GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES A cross sector review of the new UK GAAP comprising FRS 100, FRS 101 and FRS 102 Spring 2013 CONTENTS PREFACE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 PART 1 – INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 16. Investment property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 17. Property, plant and equipment. . . . . . . . . . . . . . . . . . . . . . 16 18. Intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 1. The new financial reporting framework. . . . . . . . . . . . . . . 2 2. Use of full IFRS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 19. Business combinations and goodwill. . . . . . . . . . . . . . . . . 17 3. Changes from the previous proposals . . . . . . . . . . . . . . . . 2 20. Leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 4. Timeline . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 21. Provisions and contingencies . . . . . . . . . . . . . . . . . . . . . . . 20 5. Commercial and practical considerations. . . . . . . . . . . . . 3 22. Liabilities and equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 6. Final thoughts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 23. Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 PART 2 – ACCOUNTING DIFFERENCES 1. Scope of FRS 102 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 2. Concepts and pervasive principles . . . . . . . . . . . . . . . . . . . 5 3. Financial statement presentation . . . . . . . . . . . . . . . . . . . 5 4. Statement of financial position (‘balance sheet’) . . . . . . 6 5. Statement of comprehensive income and income statement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 24. Government grants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 25. Borrowing costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 26. Share-based payment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 27. Impairment of assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 28. Employee benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 29. Income tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 30. Foreign currency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 6. Statement of changes in equity and statement of income and retained earnings. . . . . . . . . . . 7 31. Hyperinflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 7. Statement of cash flows . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 33. Related party disclosures. . . . . . . . . . . . . . . . . . . . . . . . . . . 27 8. Notes to the financial statements (general requirements) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 34. Specialised activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 9. Consolidated and separate financial statements. . . . . . . 9 10. Accounting policies, estimates and errors. . . . . . . . . . . . . 10 11. Basic financial instruments . . . . . . . . . . . . . . . . . . . . . . . . . 11 12. Other financial instrument issues . . . . . . . . . . . . . . . . . . . 13 13. Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 14. Investments in associates (consolidated financial statements) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 15. Investments in joint ventures (consolidated financial statements) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 32. Events after the end of the reporting period . . . . . . . . . . 27 35. Transition to FRS 102 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 APPENDIX 1 I&E account and balance sheet for a hypothetical charity . . . 30 APPENDIX 2 I&E account and balance sheet for a hypothetical registered provider of social housing . . . . . . . . . . . . . . . . . . . . . 32 APPENDIX 3 I&E account and balance sheet for a hypothetical education institution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 ACKNOWLEDGEMENTS This document has been prepared with input from a large number of the BDO not-for-profit team, but especial thanks go to James Nayler who undertook the bulk of the work. BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES 1 PREFACE We are now in the final straight of the UK accounting standard setter’s project to replace existing UK GAAP with new rules based on IFRS. Indeed, for entities that are not subject to SORPs, we have crossed the finish line as consultation papers and exposure drafts have given way to final standards applicable for periods beginning on or after 1 January 2015 at the latest. For charities, registered providers of social housing and education institutions, attention turns to the requirements of revised SORPs, development of which can now continue in earnest. This document is BDO's fourth annual publication on the new UK GAAP and not-for-profit entities. Much has changed since 2009 when the ASB first consulted on the replacement of UK GAAP for non-listed entities with the IFRS for SMEs. The output of this consultation came towards the end of 2010, which saw the first formalised proposals for a 3-tier approach to financial reporting. This would have seen 'publicly accountable entities' comply with full IFRS, and non-small, non-publicly accountable entities prepare financial statements in accordance with an accounting standard known as the FRSME. This was to be supplemented with a separate exposure draft addressing the accounting for transactions commonly entered into by public benefit entities known as the FRSPBE in early 2011. The start of 2012 saw the FRSME and FRSPBE give way to revised proposals in the form of FREDs 46, 47 and 48, the latter known as The Financial Reporting Standard Applicable in the UK And Republic of Ireland (or ‘The FRS’ for short). Now at the start of 2013 we have the final product of these consultations and exposure drafts. Much of what was proposed this time last year in FREDs 46, 47 and 48 has come to fruition, with perhaps the biggest change in the last 12 months not really being changes to the proposed accounting rules, but the shake-up of the regulatory environment. This has seen the disbandment of the UK’s Accounting Standards Board, with the accounting standard setting powers now residing with the Financial Reporting Council, which takes recommendations from the newly established Accounting Council. In this fourth publication we look at the changes to the proposals set out this time last year, consider the issues that those tasked with revising the charities, housing and education SORPs are likely to focus on as well as provide an overview comparison of what the final proposals mean for charities, registered providers of social housing and education institutions. As ever, if you wish to discuss how the changes to UK GAAP will affect you, please feel free to contact us. Don Bawtree Head of Not-For-Profit GLOSSARY ASB Accounting Standards Board of the UK IAS International Accounting Standard EBITDA Earnings before interest, tax, depreciation and amortisation IASB International Accounting Standards Board IFRS International Financial Reporting Standard FRC Financial Reporting Council FRED Financial Reporting Exposure Draft IFRSs International Financial Reporting Standards as adopted for use in Europe by the European Union FRS Financial Reporting Standard FRS 100 FRS 100 Application of Financial Reporting Requirements IFRS for SMEs International Financial Reporting Standard for Small and Medium-sized Entities FRS 101 FRS 101 Reduced Disclosure Framework PBE Public Benefit Entity FRS 102 FRS 102 The Financial Reporting Standard Applicable in the UK and Republic of Ireland PFI/PPP Public Finance Initiative / Public Private Partnership RP Registered provider of social housing FRSME Draft Financial Reporting Standard for Medium-sized Entities SFA Skills Funding Agency FRSPBE Draft Financial Reporting Standard for Public Benefit Entities SOCI Statement of Comprehensive Income SOFA Statement of Financial Activities FRSSE Financial Reporting Standard for Smaller Entities SORP Statement of Recommended Practice HE&FE Higher Education and Further Education SSAP Statement of Standard Accounting Practice HEFCE Higher Education Funding Council for England UITF Urgent Issues Task Force HEI Higher Education Institution UK GAAP I&E Income and Expenditure Account Generally Accepted Accounting Practice in the United Kingdom 2 BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES PART 1 – INTRODUCTION 1. THE NEW FINANCIAL REPORTING FRAMEWORK On 22 November 2012 the FRC published FRS 100, which sets out the new 3-tier framework for financial reporting in the UK. This framework, set out in the diagram below, is unchanged from the proposals issued last year in FRED 46. May voluntarily apply TIER 3 Apply FRSSE if qualifying as a small entity by reference to size criteria in Companies Act Qualifying entities Reduced disclosure (FRS 101) Qualifying entities May voluntarily apply TIER 2 Apply FRS 102 if not qualifying as small and not required to apply EU endorsed IFRS May voluntarily apply TIER 1 Apply EU endorsed IFRS if required to do so by legislation or regulation Reduced disclosure (FRS 102) On the same day the FRC also published FRS 101 (based on FRED 47 also exposed in 2012), which sets out the disclosure exemptions available to tier 1 qualifying entities (subsidiaries' and parent entities) choosing to apply the recognition and measurement rules of full IFRS in their indivdual financial statements. Finally, and most significantly, 14 March 2013 saw the FRC issue FRS 102. Originally expected to be published at the same time as FRSs 100 and 101, the Accounting Council decided in October 2012 to expose additional guidance on the accounting for multi-employer defined benefit schemes and service concession arrangements (ie PFI- or PPP-type contracts) from the perspective of the party awarding the contract. This resulted in the publication of FRS 102 being delayed by a few months, with its requirements reflecting not just the output from the major consultation exercise on FRED 48 last year, but also the output from this mini consultation. 2. USE OF FULL IFRS It remains to be seen whether any not-for-profit entities will choose to prepare accounts in accordance with full IFRS. Charities are currently prohibited from preparing full IFRS accounts and there is little to suggest this will change going forward. Whether other not-for-profit entities will be permitted to prepare full IFRS financial statements for regulatory purposes remains to be seen. To the extent they are permitted, application difficulties may arise if the revised SORPs only interpret FRS 102 for their respective sectors. We anticipate very few not-for-profit entities will prepare full IFRS accounts even if permitted, and therefore believe application of FRS 101 in individual accounts of group entities will similarly be very limited. An interesting conundrum will also arise if an entity finds itself required to do full IFRS accounts under one set of regulations (say because it has a listing on a regulated market whose rules or related legislation require the submission of full IFRS accounts), while at the same time being precluded from preparing full IFRS accounts for other regulatory purposes. It may mean separate sets of accounts would have to be prepared for each purpose, although we suspect very few not-for-profit entities, if any, will find themselves in the position of being required to prepare full IFRS accounts. 3. CHANGES FROM THE PREVIOUS PROPOSALS Whereas the proposals in FREDs 46-48 contained significant revisions to the content of the earlier FRSME and FRSPBE, the final versions of FRSs 100, 101 and 102 broadly reflect the proposals contained in FREDs 46, 47 and 48 respectively. Nonetheless, there are some key changes to the previous proposals that will affect not-for-profit entities, which we set out below. GRANT ACCOUNTING AND INCOME FROM NON-EXCHANGE TRANSACTIONS FRED 48 proposed giving entities a choice between the accruals model and performance model for grant accounting, whilst requiring the performance model for income from non-exchange transactions. However, there was no guidance in FRED 48 to help an entity establish whether a particular receipt was to be classified as a grant (for which there was to be accounting policy choice) or as income from a non-exchange transaction (for which there was no accounting policy choice). Therefore, FRS 102 clarifies that the accounting set out for grants (ie a choice between the accrual and performance models) only applies to government grants. In this context, government can include government agencies whether local, national or international. Grants from non-governmental sources would be treated the same as any non-exchange transaction (such as a donation) and would be recognised in the income statement once the entity has satisfied any performance conditions attaching to their retention. PERFORMANCE CONDITIONS AND RESTRICTIONS FRED 48 defined a performance-related condition as ‘a requirement that specifies that a resource is either to be used by the recipient as specified or if not so used to be returned to the donor’. Such a definition was more akin to what most not-for-profit entities would have considered a ‘restriction’. A restriction, by contrast, was defined in FRED 48 as ‘a requirement that limits or directs the purpose for which a resource may be used but does not require the resource to be returned if...not used as specified’. Such a definition was anathema to many in the not-for-profit sector as by definition all donations given under trust must be applied towards the purposes for which they are given. Following concerns raised by constituents in their responses to FRED 48, FRS 102 redefines a restriction as a ‘requirement that limits or directs the purposes for which a resource may be used that does not meet the definition of a performance-related condition.’ A performance-related condition is in turn defined as ‘a condition that requires the performance of a particular level of service or units of output to be delivered, with payment of, or entitlement to, the resources conditional on that performance.’ BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES The upshot is that entities other than charities may see an acceleration in their income recognition policies as non-governmental income subject only to restrictions will be recognised as income when receivable, as opposed to when the related expenditure is recognised in the I&E account (eg through depreciation). The requirements of FRS 102, however, are similar to the current charity SORP and therefore there should be greater cross-sector alignment of revenue recognition policies. CHARITIES 1 January 2014 31 December 2014 Comparative period income statement and cash flow Date of transition 31 December 2015 Current period income statement and cash flow Comparative balance sheet date First Financial Statements under FRS 102 MULTI-EMPLOYER DEFINED BENEFIT PENSIONS SCHEMES In October 2012, the Accounting Council exposed an amendment to FRED 48 addressing an aspect of multi-employer defined benefit scheme accounting. Most such schemes are typically accounted for as defined contribution schemes under current UK GAAP on the basis that scheme assets and liabilities cannot be reliably allocated to the participating entities. The specific issue is whether a participating employer should recognise a liability to the extent that an agreed funding plan has been put in place to plug existing scheme deficits. FRS 102 requires a liability for any such commitment to be recognised. This could have significant implications for not-for-profit entities, particularly RPs and HEIs, as many have entered into such deficit reduction commitments. Current UK GAAP (FRS 17) has not been amended to explicitly require this treatment prior to being replaced by FRS 102. SERVICE CONCESSION ARRANGEMENTS FRED 48 contained guidance on how to account for service concession arrangements for the construction, upgrade, operation and maintenance of infrastructure assets. These arrangements generally encompass PFI and PPP contracts (although not exclusively). However, whereas FRED 48 only addressed the accounting from the operator’s perspective, FRS 102 also includes guidance from the perspective of the grantor, ie the party awarding the contract. Whilst this may not seem to be immediately relevant to notfor-profit entities, some do enter into similar arrangements, and therefore could be relevant to the not-for-profit sector. For instance, an HEI (grantor) may enter into an arrangement with, say, a private sector entity or RP (operator) to renovate student accommodation in return for granting various rights and responsibilities over the property for a period of time. 4. TIMELINE The backstop date for adoption of UK GAAP is unchanged from last year’s proposals, namely periods beginning on or after 1 January 2015. However, the final standard now permits entities subject to a SORP to apply the accounting framework early to any accounting period ending on or after 31 December 2012 providing the accounting requirements do not conflict with a currently effective SORP or other legal requirements. Given that currently effective SORPs do conflict with certain aspects of FRS 102, the practical consequence of this may be limited, with charities, RPs and HE&FE institutions likely to wait for the publication of revised SORPs at the earliest before transitioning to the new accounting framework. Assuming most not-for-profit entities will, post publication of revised SORPs, choose to wait until the latest possible date before applying the new UK GAAP, this gives rise to the following timelines for typical year-end dates. 3 REGISTERED PROVIDERS OF SOCIAL HOUSING 1 April 2014 31 March 2015 Comparative period income statement and cash flow Date of transition 31 March 2016 Current period income statement and cash flow Comparative balance sheet date First Financial Statements under FRS 102 EDUCATION INSTITUTIONS 1 August 2014 31 July 2015 Comparative period income statement and cash flow Date of transition 31 July 2016 Current period income statement and cash flow Comparative balance sheet date First Financial Statements under FRS 102 Whichever financial statements are first prepared in accordance with the new UK GAAP, it should be remembered that to be able to prepare a comparative income statement and cash flow in the first financial statements affected, it will also be necessary to prepare a balance sheet at the start of the comparative period, ie the ‘date of transition’. To all intents and purposes the date of transition means the balance sheet date two years before the date of the first financial statements prepared in accordance with FRS 102. 5. COMMERCIAL AND PRACTICAL CONSIDERATIONS There are a number of commercial and practical considerations to think about when transitioning to the new accounting framework set out in FRSs 100, 101 and 102. Some of these are outlined below. FINANCIAL POSITION AND PERFORMANCE The recognition and measurement of assets, liabilities, income and expenditure will change, as well as their presentation. This will affect the reported performance, net assets and reserves of not-for-profit entities. Organisations will therefore need to consider the effect this may have on stakeholders and funders. TRAINING NEEDS Finance teams, finance committees, audit committees and voluntary boards will need to be trained in the new accounting rules applicable to the accounting framework adopted. Systems will also need to be put in place to ensure that, for consolidation purposes, the right information is collected by group accountants. 4 BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES Large and complex groups may, for good reasons, have group entities applying different accounting frameworks to each other or to rules applied on consolidation. Such organisations will need to consider whether the responsibility for reconciling entity numbers to the consolidated reporting rests with the entity or with the group accountants. The decisions made will have repercussions for the training requirements. TAX IMPLICATIONS There could be potential implications on the tax liabilities of non charitable group entities arising from changes to accounting profit and, consequently, the amount of gift aid donations to be paid. It will also be very important to revisit tax structures that are dependent on current UK GAAP to determine whether the change in accounting would change the effectiveness of these structures in mitigating tax. LOAN COVENANTS If loan covenants are set by reference to UK GAAP amounts in either audited financial statements or management accounts, it will be necessary to consider whether the new accounting rules will adversely affect an entity’s ability to meet those loan covenants. In the current economic climate there is a risk that the banks will take the opportunity to renegotiate loan terms. ONE-OFF TRANSITION COSTS Entities may incur one-off costs as a result of needing the help of external advisers to assist in the transition to the new UK GAAP. EXEMPTIONS FROM FULL RETROSPECTIVE APPLICATION The basic principle is that comparatives and current period numbers in the first financial statements affected must be presented using the same accounting policies. In order for a comparative income statement to be presented in those financial statements it requires a transition date balance sheet to be prepared, which will be two years prior to the first balance sheet date for which numbers are required in accordance with the new regime. However, various exemptions and exceptions from full retrospective application are available in FRS 102, which are discussed in more detail in Part 2 Section 35 of this guide. Entities will need to consider which of these exemptions they are going to apply. FUTURE DEVELOPMENTS A number of significant accounting changes have recently either been brought into full IFRS or are anticipated to come into effect in the near future. These include the accounting for leases, subsidiaries, joint ventures, revenue and financial instruments. Consistent with the proposals in FRED 48, many of the changes have not been factored into FRS 102. However, given the IASB's intention to update the IFRS for SMEs for changes made to full IFRS and the Accounting Council's policy of aligning the new UK GAAP with the IFRS for SMEs to the extent compatible with law, it is possible that FRS 102 will be subject to further revisions soon after its effective date. Therefore, entities should keep an eye on accounting developments in full IFRS in order to anticipate likely changes to FRS 102 in the coming years. In addition, although the FRSSE is being retained and would be available for use by any small entity (determined by reference to size criteria in companies’ legislation), in time the FRSSE may also be withdrawn meaning that small entities choosing to apply the FRSSE under the new accounting framework would sooner or later be required to apply the accounting in FRS 102. 6. FINAL THOUGHTS The replacement of current UK GAAP with the new framework set out in FRSs 100, 101 and 102 could provide a significant challenge to many notfor-profit entities. The experience of listed companies that had to transition from UK GAAP to full IFRS in recent years is that early consideration of the issues and a project plan to manage the transition pays dividends in the long-run. Those that waited until preparation of the first financial statements affected before tackling the project ended up wishing they had started earlier. The same is likely to be true for those entities now faced with transitioning from current UK GAAP to FRS 102. As ever, if you have any queries arising from this publication, or wish to consider further the impact these proposals would have on your financial reporting, please do not hesitate to get in touch with your usual BDO contact. PART 2 – ACCOUNTING DIFFERENCES We have analysed the accounting differences into 35 sections, one for each of the sections in FRS 102. Each section discusses the requirements of FRS 102 and compares it to current accounting practice adopted by charities, RPs and education institutions. We have updated last year’s publication by including a description of the key changes made to the previous proposals set out in FRED 48. For completeness we have retained a comparison where relevant with full IFRS. Although it now seems unlikely that any not-for-profit entity will have to apply full IFRS, the extent to which any not-for-profit entity will be able, or want, to apply what could be viewed as the ‘gold standard’ of financial reporting is unknown. Where appropriate, the heading of each section makes use of the following key to indicate the level of relevance to not-for-profit entities. Number of entities affected Charities HE&FE Institutions Registered Providers Many Some Few Most sections also end with a bullet point summary making use of a traffic light system to identify the likely significance of the change in accounting for entities applying FRS 102. High significance Medium significance Low significance BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES 1. SCOPE OF FRS 102 BACKGROUND FRS 102 is the new accounting standard that is to be applied by: n any entity that is not required to apply IFRSs or otherwise chooses not to apply IFRSs n any small entity that, although eligible to apply the FRSSE, chooses not to do so. Although the current charity SORP briefly addresses accounting under the FRSSE, most charities do not apply the FRSSE albeit that many are permitted to do so. It is unclear how many charities will apply the FRSSE rather than FRS 102. On the basis that the current charity SORP is arguably in line with the FRSSE, small charities may choose to apply the FRSSE on the basis that it would not seen any change to their current accounting policies. However, this could just be postponing adoption of FRS 102 as it it possible that in due course the FRSSE will be withdrawn. OPERATING SEGMENT DISCLOSURE Any entity that has listed debt or is in the process of issuing listed debt, must additionally apply IFRS 8 Operating Segments. In the not-for-profit sector this will predominantly apply to RPs, some of whom may find they have to disclose more information about their results and net assets. In their financial statements at present, RPs are already required to give a detailed breakdown of their income and expenditure, but it is not necessarily the case that these disclosures are fully in accordance with the requirements of IFRS 8. REDUCED DISCLOSURE FRAMEWORK FOR QUALIFYING ENTITIES A qualifying entity is defined as 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 member is included in the consolidation.’ Such an entity need not provide the following disclosures otherwise required by FRS 102: n The requirement in section 4 ‘Statement of Financial Position’ to disclose a reconciliation of the number of shares outstanding at the beginning and end of the period (only relevant if the entity is incorporated with share capital) n Section 7 ‘Statement of Cash Flows’ n Sections 11 and 12 dealing with financial instruments, provided the equivalent disclosures required by these sections are included in the consolidated financial statements of the group in which the entity is consolidated. However, entities may have to comply with certain Companies Act 2006 disclosure requirements otherwise dealt with in Section 11 n Section 26 ‘Share-based Payment’ (unlikely to be of relevance to not-for-profit entities) n The requirement in Section 33 'Related Party Disclosures' to disclose compensation of key management personnel (although this may still be separately required by separate legislation or regulation, such as the Companies Act 2006). A qualifying entity must comply with the other disclosure requirements of Section 33. ‘Qualifying entity’ is therefore referring to both the separate financial statements of the parent of a group as well as its subsidiaries. Note that for non-wholly owned subsidiaries the disclosure concessions are only available if a certain proportion of minority shareholders do not object. No disclosure exemptions are available in the group accounts of intermediate parent entities voluntarily preparing consolidated financial statements. 5 2. CONCEPTS AND PERVASIVE PRINCIPLES This section of FRS 102 describes the objective of financial statements and the qualities that make the information in such financial statements useful, eg relevance, reliability, materiality, and substance over form. It also acknowledges that the benefits derived from producing financial information in accordance with FRS 102 should exceed the cost of providing the information. This section also sets out the concepts and basic principles underlying such financial statements, including: n definitions for assets, liabilities, income and expense n setting the tone for when transactions should be recognised n discussing the appropriate basis of measuring items in the financial statements (historical cost or fair value). This is not fundamentally different from the ASB’s Interpretation for Public Benefit Entities of its Statement of Principles for Financial Reporting save that the latter has some change of emphasis and re-expression to make it more relevant to public benefit entities. The Statement of Principles will cease to be effective once FRS 102 is adopted. 3. FINANCIAL STATEMENT PRESENTATION This section explains what is meant by fair presentation of financial statements, what compliance with FRS 102 requires and what a complete set of financial statements is. Compliance with FRS 102, with additional disclosure where necessary, is presumed to result in the financial statements showing a true and fair view. Only in extremely rare circumstances is it envisaged that it might be necessary to invoke a true and fair override. FRS 102 contains no requirements as to narrative reporting outside of the financial statements (eg operating and financial reviews, trustee reports, etc), although the Accounting Council does identify this as a topic that may be developed in future updates of the standard. FRS 102 contains certain accounting treatments reserved only for PBEs. These are discussed in more detail later in this document. However, Section 3 specifically requires any entity applying these reserved accounting treatments to make an explicit and unreserved statement that it is a PBE. 6 BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES PUBLIC BENEFIT ENTITIES (PBEs) FRS 102 defines a PBE as an 'entity whose primary objective is to provide goods or services for the general public, community or social benefit and where any equity is provided with a view to supporting the entity’s primary objectives rather than with a view to providing a financial return to equity providers, shareholders or members.’ A footnote to the definition clarifies that the term public benefit entity ‘does not necessarily imply that the purpose of the entity is for the benefit of the public as a whole. For example, many PBEs exist for the direct benefit of a particular group of people, although it is possible that society as a whole also benefits indirectly. The important factor is what the primary purpose of such an entity is, and that it does not exist primarily to provide economic benefits to its investors. Organisations such as mutual insurance companies, other mutual co-operative entities and clubs that provide dividends or other economic benefits directly and proportionately to their owners, members or participants are not PBEs.’ Whilst it therefore seems clear that charities, RPs and HEIs would all fall to be treated as PBEs there are perhaps other types of not-for-profit entities where it is less clear cut and judgement may need to be made. For example, trade unions arguably provide economic benefits to members, but not necessarily proportionately. Similarly judgements may need to be made by other types of membership organisation such as professional bodies, political parties, clubs and societies. SUMMARY Issue FRS 102 Current UK GAAP and SORPs Pension liability Subsumed within provisions for liabilities. Presented Presented separately on face separately on face of balance sheet. of balance sheet. Endowment assets for HE&FE institutions Allocated Presented as a according to the separate line nature of the item. underlying endowment asset (implied). Allocated according to the nature of the underlying endowment asset (implied). Programme related investment for charities Allocated according to the nature of the underlying asset (implied). Allocated according to the nature of the underlying asset (implied). Presented as a separate line item. Social Presented gross as Netted against housing grant a liability separate underlying (SHG) in RPs from the property asset. underlying property asset. EU endorsed IFRS Presented gross as a liability separate from the underlying property asset. 4. STATEMENT OF FINANCIAL POSITION (‘BALANCE SHEET’) 5. STATEMENT OF COMPREHENSIVE INCOME AND INCOME STATEMENT FRS 102 cross refers to the balance sheet formats in companies’ legislation. As the balance sheets of most not-for-profit entities currently tend to broadly follow the formats in companies legislation, we do not anticipate much change save for the following observations: ONE OR TWO STATEMENT APPROACH n the requirement to present the defined benefit pension liability (if any) on the face of the balance sheet comes from FRS 17 Retirement benefits, and is not in FRS 102. Consequently, using the balance sheet formats in companies’ legislation, it may be that entities will subsume such pension liabilities within the ‘provision for liabilities’ line n the HE&FE SORP requires endowment assets to be shown separately from other assets in the balance sheet. It is unclear whether such assets would need to be allocated to the appropriate asset category (eg cash) and not presented as a separate line item n The current charity SORP addresses the accounting for programme related investments, requiring such assets to be presented in the balance sheet as a sub-category of ‘investments’. If the underlying asset is more akin to, say, an item of property, plant and equipment, then it might be expected that going forward it would be presented accordingly. Reference should be made to the most recent guidance from the Charity Commission on investments (CC14) n Social Housing Grant (SHG) is likely to be presented gross in the balance sheet of RPs as a liability rather than netted against social housing properties. There may, however, be significant changes in presentation for entities whose current balance sheet formats do not resemble the formats set out in companies’ legislation. FRS 102 permits performance to be presented in one of two ways. Firstly, it allows the presentation of a single statement of comprehensive income (SOCI). This is similar to the SOFA prepared by charities with ‘traditional’ items of income and expense presented in the top part of the SOFA, giving rise to a net income figure. The bottom part is reserved for other gains and losses (broadly speaking items that under current UK GAAP would be presented in a separate statement of total recognised gains and losses). These other gains and losses are referred to in FRS 102 as items of ‘other comprehensive income’ which, when added on to the net income figure, give an entity’s total comprehensive income for the period. As an alternative to a single SOCI, an income statement can be presented on its own with a separate statement containing the items of other comprehensive income. This is effectively the same approach as is currently applied by RPs and education institutions with separate presentation of (i) an I&E and (ii) a statement of total recognised gains and losses. In the rest of this document, reference to ‘income statement’ means the top part of the SOCI if the single statement approach is adopted, or the separate income and expenditure account if the two statement approach is adopted. Similarly, reference to ‘other comprehensive income’ means the bottom part of the SOCI (single statement approach), or the separate statement of other comprehensive income (two statement approach). BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES GENERAL PRESENTATION As with the presentation requirements for the balance sheet, FRS 102 requires use of the formats set out in companies’ legislation irrespective of whether the entity is legally constituted as a company. However, unlike their balance sheet formats, the I&E formats used by not-for-profit entities, and set out in SORPs, have a noticeably different ‘feel’ from the profit and loss accounts presented by many companies. Indeed, the supplementary material published with FRED 48 noted that one of potential impacts of the proposals on a large charity (whether or not it is incorporated as a company) is that it will need to review the current format of its primary statements to ensure compliance with the formats specified in Company Law. Arguably though, current formats would still be available for use on transition to FRS 102 as companies’ legislation permits companies to adapt the formats where appropriate, if required by the special nature of an entity’s business. It might be possible, therefore, to argue that the majority of I&Es presented by not-for-profit organisations are to a large extent compliant with the formats in companies’ legislation. Although considered separate from the I&E account, it remains a moot point whether transfers between a charity's funds and reserves can be presented at the foot of a single statement like the SOFA, or whether such movements need to be presented as a separate primary statement.Those tasked with writing the revised charity, housing and education SORPs are, no doubt, considering primary statement presentation as part of their work. ADDITIONAL LINE ITEMS AND EXCEPTIONAL ITEMS As with current UK GAAP, FRS 102 permits presentation of additional line items, headings and subtotals when such presentation is relevant to an understanding of the entity’s financial performance. It does not use the term ‘exceptional item’, but if an item of income or expense is of such importance to the users’ understanding of the financial statements it should be presented separately and so the concept of an exceptional item does exist. Although FRS 102 does not require disclosure of an operating surplus figure, it does require that any entity choosing to present such a performance measure should include debits such as ‘inventory write-downs and restructuring and relocation expenses’ whether or not ‘they occur irregularly or infrequently or are unusual in amount’. This differs from current UK GAAP where FRS 3 Reporting Financial Performance specifically requires three exceptional expenses to be presented after operating profit: n profits or losses on the sale or termination of an operation n costs of a fundamental reorganisation or restructuring having a material effect on the nature and focus of the reporting entity's operations n profits or losses on the disposal of fixed assets. The Charity Commission has recently issued guidance stating that a loss arising from fraud does not constitute charitable application of funds. It remains to be seen whether the revised charity SORP will address which line item in the I&E account such losses should be included under FRS 102. NOTE OF HISTORICAL COST PROFITS AND LOSSES FRS 102 does not require presentation of a note of historical cost profits and losses. 7 SUMMARY Issue FRS 102 Current UK GAAP and SORPs EU endorsed IFRS Presentation of gains and losses Choice of (i) a single statement of comprehensive income or (ii) an income statement presented as a standalone statement with a separate statement of other comprehensive income. I&E presented separately from statement of recognised gains and losses, except for a charity’s SOFA which also incorporates a reconciliation of funds. Choice of (i) a single statement of comprehensive income or (ii) an income statement presented as a standalone statement with a separate statement of other comprehensive income. Exceptional items All exceptional items charged in arriving at operating surplus / (deficit). Certain exceptional items must be charged after operating surplus / (deficit). All exceptional items charged in arriving at operating surplus / (deficit). Note of historical cost profits and losses Not required. Required. Not required. 6. STATEMENT OF CHANGES IN EQUITY AND STATEMENT OF INCOME AND RETAINED EARNINGS The term ‘equity’ is not really used by not-for-profit entities, but is essentially the difference between an entity’s assets and liabilities and therefore represents its funds or reserves. FRS 102 requires a statement of changes in equity as a primary statement, with movements on each component of equity (ie each fund or reserve) being shown separately for both the current and prior period. Under current UK GAAP and the SORPs, entities usually present a statement of movement on each fund in the notes (for the current period only), with a single statement of the movement in aggregate funds presented as either a primary statement or in the notes in accordance with FRS 3 (current and prior period). Where the changes in an entity’s reserves or funds arise only as a result of: n profit or loss (ie income less expenditure) for the period, with no items of other comprehensive income; n dividends payable (unlikely to be relevant for not-for-profit entities); or n the effects of material prior period adjustments then FRS 102 allows an entity to show a single statement of income and retained earnings. This is the single statement of comprehensive income referred to in section 5, extended further down the statement for these three items to give the total change in net assets during the period. 8 BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES If an entity makes transfers between funds and reserves in the period without affecting aggregate net assets, FRS 102 would not seem to permit a single statement of income and retained earnings. The same is true when there are no transfers between reserves, only an allocation of total comprehensive income to specific reserves. It is expected that most not-for-profit entities would want to show this information clearly and therefore choose to present a separate statement of changes in their reserve and funds position. This is particularly true for charities where total return accounting might apply in respect of their endowment funds. FRS 102 makes no reference to designated funds, which are only internal earmarking decisions common in some not-forprofit entities. However, it does not preclude their presentation in the statement of financial position, or transfers between them being made. SUMMARY Issue Presentation of changes in funds and reserves FRS 102 Presented separately as a primary statement except in certain circumstances where it can be appended to the single statement of comprehensive income to form a single Statement of Income and Retained Earnings. Current UK GAAP and SORPs EU endorsed IFRS Presented as either a primary statement or in notes, except for charity SORP where it forms part of the SOFA. Presented separately as a primary statement. REVISIONS MADE TO PROPOSALS IN FRED 48 FRS 102 contains some guidance on when it is permitted to net off cash payments and receipts, namely when: n They reflect the activities of the customer rather than the entity (such as the acceptance and repayment of demand deposits by a bank); or n The cash flow turnover is quick, the amounts large and the maturities short (such as the purchase and sale of investments). SUMMARY Issue FRS 102 Current UK GAAP and SORPs EU endorsed IFRS Categories of cash flows All cash flows categorised as operating, investing or financing activities. Potentially nine separate cash flow headings. All cash flows categorised as operating, investing or financing activities. Definition of cash Includes cash equivalents, ie available in three months without penalty. Only includes cash available on demand without penalty. Includes cash equivalents, ie available in three months without penalty. Presentation Presented on the of cash flows face of the cash from operating flow statement. activities Reconciliation of net operating income to cash flow from operating activities usually presented in the notes. Presented on the face of the cash flow statement. Cash flow from endowment income Presented as financing cash flows. Presented as operating cash flows. Reconciliations Not required. of net debt Required. Not required. Parent company cash flow statement No specific exemption, but practice has developed such that it is not given. Required. 7. STATEMENT OF CASH FLOWS The format of the cash flow statement in FRS 102 is divided into only three sections, with all cash flows being classified as relating to operating, investing or financing activities. This contrasts with current UK GAAP (FRS 1 Cash flow statements) where cash flows are allocated to potentially nine separate sections of the cash flow statement. Other differences are: n ‘cash’ for cash flow statement purposes prepared under UK GAAP means those balances that are available on demand without penalty, whereas the statement of cash flows prepared under FRS 102 is a statement of movements in cash and cash equivalents (with deposits accessible within a three month time-frame suggested as meeting the definition of cash equivalents) n the analysis of cash flows from operating activities are generally presented on the face of the statement, rather than relegated to the notes as often happens under current UK GAAP n cash flows from endowment income recognised in the income statement might be presented as operating cash flows under FRS 102 rather than cash flows from financing activities n FRS 102 requires no reconciliations of net debt. Presented as operating cash flows. Not required under reduced disclosure exemptions set out in section 1. BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES 8. NOTES TO THE FINANCIAL STATEMENTS (GENERAL REQUIREMENTS) SUMMARY Issue FRS 102 Current UK GAAP and SORPs Volume of disclosures in consolidated financial statements Potentially less extensive than UK GAAP, although will still need to give any additional disclosures required by legislation and regulators. More extensive Extensive than FRS 102, less disclosure extensive than requirements. IFRSs. Operating segments Apply IFRS 8 if have listed debt or are in the process of issuing listed debt. RPs must provide breakdown of operating results. Apply IFRS 8 if have listed debt or are in the process of issuing listed debt. Volume of disclosures in subsidiary financial statements Reduced disclosure framework available. No reduced disclosure framework, although certain exemptions exist in standards and companies’ legislation. N/A. Reduced disclosure framework is a UK GAAP concept. Disclosure of key assumptions concerning the future Required. Not explicitly required. Required. This section of FRS 102 specifically requires disclosure of: n judgements made by management in the process of applying the entity’s accounting policies n key assumptions concerning the future, and other key sources of estimation uncertainty at the reporting date that have a significant risk of causing material adjustments to the carrying amounts of assets and liabilities. Current UK GAAP (FRS 18 Accounting policies) only requires disclosure of significant estimation techniques. In addition to these general requirements each financial statement area addressed by FRS 102 (see sections 9 to 35 below) requires certain disclosures to be made. Of course all disclosure items are not going to be relevant to any single entity (eg an entity without a defined benefit pension scheme can ignore all disclosures relating to such schemes). However, not-for-profit entities should still be cognisant of other disclosure requirements imposed by the revised SORPs, legislation and the following regulatory requirements, as these will still be needed in annual financial statements: n Charities - Charities (Accounts and Reports) Regulations 2008 and the Charities Accounts (Scotland) Regulations 2006 n Registered Providers of Social Housing - Accounting Direction for Private Registered Providers of Social Housing 2012 n Education Institutions - Accounts Directions issued by the SFA and HEFCE. In addition, as noted in Section 1 above, any entity that has listed debt or is in the process of issuing debt must comply with IFRS 8 Operating Segments. 9 EU endorsed IFRS 9. CONSOLIDATED AND SEPARATE FINANCIAL STATEMENTS ACCOUNTING FOR SUBSIDIARIES The principles contained in FRS 102 concerning the accounting for subsidiaries are very similar to those in current UK GAAP (FRS 2 Accounting for subsidiary undertakings) in terms of determining the existence of control and parent-subsidiary relationships as well as the actual consolidation accounting procedures to apply. Consistent with the proposals contained in FRED 48, FRS 102 does not contain any further specific guidance on the meaning of control within a PBE context, and therefore any supplementary guidance would need to be provided by the revised SORPs if thought necessary. SEPARATE FINANCIAL STATEMENTS If a parent entity prepares consolidated financial statements, FRS 102 does not require it to publish its own separate financial statements, instead noting that the requirements for the presentation of separate financial statements is set out in relevant legislation. The charity and HE&FE SORPs follow the approach in companies’ legislation requiring only the parent entity’s individual balance sheet to be presented provided its result for the period is disclosed. RPs incorporated under the Industrial and Provident Societies Acts are required to present a parent’s individual accounts in full as well as its consolidated accounts. There is no indication at present that this approach to presentation of separate financial statements will change. 10 BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES INVESTMENTS IN SUBSIDIARIES, ASSOCIATES AND JOINTLY CONTROLLED ENTITIES Under FRS 102 an entity may account in its separate financial statements for interests in subsidiaries, associates and jointly controlled entities at: SUMMARY Issue FRS 102 Current UK GAAP and SORPs EU endorsed IFRS Parent entity’s financial statements No requirement to present a parent entity’s individual accounts if consolidated accounts are prepared, although may continue to be required by legislation or regulators. Usually required to present information in relation to the parent (varies depending on type of entity). No requirement to present a parent entity’s individual accounts if consolidated accounts are prepared, although may continue to be required by legislation or regulators. Accounting for investments in subsidiaries, associates and jointly controlled entities (separate financial statements of parent) Choice of cost or fair value. Where fair value is chosen, changes in fair value are recognised as an item of other comprehensive income or within profit or loss. The choice is to be applied consistently to all investments within a particular class. Choice of cost or fair value through reserves. Revaluation model applied on an investment by investment basis. Fair value or cost model applied consistently to all investments within a particular class. n cost n fair value with changes recognised as an item of other comprehensive income other than decreases in fair value below cost which must be recognised in the income statement; or n fair value with changes in fair value recognised in the income statement. The policy selected must be applied consistently to all investments in a single class (subsidiaries, associates or jointly controlled entities). The accounting for investments in associates and jointly controlled entities in consolidated financial statements is addressed in sections 14 and 15 respectively. REVISIONS MADE TO PROPOSALS IN FRED 48 FRS 102 contains additional guidance on accounting for the changes in stake in another entity, dealing with situations where control is retained, obtained or lost. FRED 48 was silent on the accounting for changes in stake. Where the investor has control both before and after an increase or decrease in stake, FRS 102 requires the minority interest balance to be adjusted to reflect the revised proportion of net assets they own, with any difference between consideration paid or received adjusted in reserves. Although this treatment is consistent with full IFRS it is different to current UK GAAP, which requires this difference to be recorded as a profit or loss on disposal (in the case of a reduction in stake) or an adjustment to goodwill (in the case of increased stake). Under FRS 102, gains and losses on disposal of an interest are only recognised if the size of the stake sold results in the investor losing control such that the investee is no longer consolidated. Goodwill will only arise when an investor takes an increased stake if, as a result of the transaction, the investor obtains control of the investee and therefore falls to be consolidated for the first time. In this situation, FRS 102 is aligned with current UK GAAP. Furthermore, FRS 102 now contains an exemption from consolidation for any entity that is small and not ineligible under legislation. Under the proposals in FRED 48, a small entity wishing to obtain an exemption from consolidation would have had to have chosen to apply the FRSSE under the new accounting framework. 10. ACCOUNTING POLICIES, ESTIMATES AND ERRORS This section of FRS 102 distinguishes the required accounting for changes in accounting policies, changes in estimates made in previous periods and restatements of prior period errors. FRS 102 requires a prior period adjustment for any material prior period error. Current UK GAAP (FRS 3 Reporting financial performance) requires a prior period adjustment for correction of fundamental errors where they ‘are of such significance as to destroy the true and fair view and hence the validity of those financial statements’. This is likely to increase the frequency of any errors found having to be corrected by means of a prior period adjustment, as a fundamental error is generally accepted as meaning an error of greater significance than a material error. Revisions to estimates made in prior periods, however, are not the same as errors and, as with UK GAAP, are dealt with prospectively in the period the revision arises. No significant areas of difference between current UK GAAP and FRS 102 have been identified with regard to revisions of accounting estimates or changes in accounting policy. However, reference should be made to section 35 below, which deals with accounting policy changes arising on transition from current UK GAAP to FRS 102. REVISIONS MADE TO PROPOSALS IN FRED 48 FRS 102 specifies that, although a change in accounting policy, a decision to switch the basis of measurement of property, plant and equipment (or intangible assets) from cost to fair value is to be dealt with as a revaluation in the year of change rather than as a prior period adjustment. This makes it less onerous for an entity to chose to adopt a policy of revaluation for such assets and is in line with both full IFRS and common practice under current UK GAAP BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES SUMMARY Issue Current UK GAAP and SORPs EU endorsed IFRS Adjust by means of a prior period adjustment if the error is material. Adjust by means of a prior period adjustment if the error is fundamental. Adjust by means of a prior period adjustment if the error is material. Two years of No requirement. comparatives No requirement. Required for prior period adjustments, whether as the result of a change in accounting policy or the correction of a material error. Errors found relating to prior periods FRS 102 11. BASIC FINANCIAL INSTRUMENTS INTRODUCTION The accounting for financial instruments is split over two sections: n Section 11 dealing with basic financial instrument; and n Section 12 dealing with other financial instrument issues. Alternatively, FRS 102 permits an entity to use the full IFRS standards dealing with financial instruments (IAS 39 Financial Instruments and its replacement IFRS 9 from 2015) instead of the rules contained wholly within Sections 11 and 12 of FRS 102. The main benefit of applying the full IFRS standards is that an entity may find it is slightly less exposed to having to account for financial assets and liabilities at fair value. The downside is that the full IFRS standards are notoriously complex. Given the fluidity of developments in accounting for financial instruments in full IFRS, coupled with our expectation that most not-for-profit entities will not choose to apply the accounting rules in IAS 39 and IFRS 9, we have restricted our discussion to the rules in FRS 102. Under Section 11, a basic financial instrument is defined, broadly, as: n Cash n Loans payable and receivable with fairly straightforward returns (generally a fixed rate or a floating rate determined by reference to, say, LIBOR rates). This would include trade payables and trade receivables n Investments in ordinary equity shares n Commitments to make or receive a loan. Accounting for most financial instruments under current UK GAAP has developed by convention due to a general lack of guidance in accounting standards and SORPs. However, those accounting conventions are not always consistent with the rules on financial instruments in FRS 102. That is not to say the accounting for financial instruments will necessarily change dramatically on transition from current UK GAAP for all entities, 11 but the extent to which entities will be affected is going to be driven by the types of financial instruments they have and the complexity of the contracts they have entered into. However, typical areas where entities may see a change from current practice is the accounting for: n Investments in other entities n loans granted at off-market rates of interest (both loans payable and loans receivable) unless the entity meets the definition of a public benefit entity n trade debtors and related bad debt provisions n disclosure INVESTMENTS The charity, HE&FE and housing SORPs take a different approach to the accounting for investments. Both the charity and housing SORPs require all investments to be measured at fair value. The HE&FE SORP adopts a mixed cost and fair value measurement approach driven by whether the investments are classified as current assets (cost) or fixed assets (fair value if listed). Changes in fair value are also treated differently. The charity SORP requires changes in fair value (other than permanent diminutions in value) to be shown in the ‘gains and losses on investments’ line in the bottom part of the SOFA. The HE&FE and housing SORPs require fair value gains and losses to be recognised in the statement of total recognised gains and losses, except for falls in value below original cost, which are recognised in the income statement. FRS 102 by contrast requires all changes in the fair value of equity investments to be shown in the income statement. Investments in all non-complex debt instruments, on the other hand, are measured at amortised cost. The treatment of investments that do not meet the definition of financial instruments (eg certain program related investments and mixed motive investments of charities) is likely to be driven by the nature of the underlying assets. Those tasked with writing the revised charity SORP may need to consider whether the guidance in CC14 issued by the Charity Commission is consistent with the requirements of FRS 102. CONCESSIONARY LOANS Unless an entity meets the definition of a PBE, debt instruments (payable and receivable) are initially measured at fair value. This would impact the accounting for loans, including intragroup loans, where the interest rate on inception is below the prevailing market rate of interest. It entails discounting the cash flows under the loan arrangement at a market rate of interest which gives rise to income (for loans payable) and expense (for loans receivable) at the point the loan is made. Subsequently, the prevailing market rate of interest on inception of the loan is imputed to accrete the loan up to the amount ultimately payable or receivable on settlement. Entities that meet the definition of a PBE, or are a member of a PBE group, are not required to follow this treatment for loans provided at off-market rates (termed ‘concessionary loans’). Instead, as an alternative, they may measure all such loans at the amounts borrowed or lent, subsequently adjusted to reflect accrued interest payable or receivable (which would be nil for an interest free loan). This is the same as current UK GAAP, save that concessionary loans must be presented as a separate line-item on the face of the balance sheet, with relevant information being disclosed in the notes (eg interest rate payable and security for the loan). 12 BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES BAD DEBT PROVISIONS Under FRS 102, an entity must have objective evidence that a a debt is impaired before it is provided against. Evidence would include known financial difficulty of the debtor or significant breach of contractual terms, such as not paying within the terms of any credit period given. What this means in practice, however, is that it would not be possible to raise general bad debt provisions against the whole portfolio of debtors. Any general provisions could only be applied against the portfolio of debtors in default based on past experience. This basis of bad debt provisioning may be different to the basis applied under current UK GAAP. OFFSETTING Like current UK GAAP (FRS 25 Financial instruments: presentation), FRS 102 contains specific rules on when a financial asset and financial liability may be offset, stating that it is only possible when the entity: n currently has a legally enforceable right to set off the recognised amounts; and SUMMARY Issue FRS 102 Current UK GAAP and SORPs EU endorsed IFRS Equity investments (other than investments in subsidiaries, associates and joint ventures) Measured at fair value with changes in value recognised in the income statement. Changes in fair value generally not recognised in I&E. HE&FE SORP does not require all investments to be measured at fair value. Measured at fair value with changes in value recognised in the income statement or reserves. Investment loans Measured at amortised cost. Measured at fair Measured at value with amortised cost or changes in fair fair value. value generally not recognised in I&E. HE&FE SORP does not require all investments to be measured at fair value. Concessionary loans (ie loans at below market rates, including interest free loans) Choice for PBEs of either (i) recognise at the amount borrowed or lent with interest charge reflecting the rate charged; or (ii) initially recognise at fair value with interest imputed over the term to repayment. Recognised at the amount borrowed or lent. Interest charge reflects the rate charged. Initially recognise at fair value with market rate of interest on inception of the loan imputed over the term to repayment. Bad debt provisioning Provide only when there is objective evidence of impairment. No specific rules. Amount of provision determined by expectation. Provide only when there is objective evidence of impairment. Disclosure To include Limited disclosure Extensive accounting requirements. disclosure policies, carrying requirements. amount by category, basis of derecognising financial assets, collateral, defaults and breaches on financial liabilities, analysis of gains and losses on financial instruments, information about fair value. n intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously. This makes it hard to offset amounts payable and receivable from the same party, for example cash surpluses and overdrafts / loan balances. This is true even when the balances are with the same bank and a master netting arrangement is in place with interest only accruing on the net amount. This is because, even in such arrangements, the second of the above two conditions is unlikely to be met, particularly when considering cash balances held by one group entity and overdrafts / loans held by another. It is likely the consolidated balance sheet would, therefore, need to reflect the cash and overdraft / loan balances on a gross basis. DISCLOSURE Entities will find that, generally, disclosure requirements are more extensive under FRS 102, largely bcause there is very little requirement for any financial instrument disclosures under current UK GAAP for unlisted entities. REVISIONS MADE TO PROPOSALS IN FRED 48 Under the proposals in FRED 48, complications would have arisen where a concessionary loan is made by an entity that, although not meeting the definition of a PBE in its own right, was a member of a PBE group. It would have resulted in the non-PBE group entity having to initially account for the loan at fair value and thereafter impute the prevailing market rate of interest in its individual financial statements even though on consolidation such accounting would have been reversed. In FRS 102, however, the accounting for concessionary loans applicable to PBEs may also be applied in the individual financial statements of any entity that is a member of a PBE group. Also, the proposals in FRED 48 did not contain the guidance set out above for offsetting financial assets and liabilities. BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES 12. OTHER FINANCIAL INSTRUMENT ISSUES SUMMARY Issue FRS 102 Current UK GAAP and SORPs EU endorsed IFRS Derivative instruments Measured at fair value. Gains and losses recognised in income statement unless hedge accounting applied, in which case movements in fair value are recognised as an item of other comprehensive income to the extent effective. Derivatives generally accounted for synthetically by assuming that the derivative changes the terms and conditions of the hedged contract. Measured at fair value. Gains and losses recognised in income statement unless hedge accounting applied. Hedge accounting Limited number of scenarios in which hedge accounting is permitted. In addition, documentation must be put in place at start of hedge with an expectation that the hedging relationship will be effective. Limited requirements in SSAP 20 dealing with foreign exchange hedges. Detailed rules on the circumstances on which hedge accounting can be applied. In addition to documenting the hedge and expecting the hedging relationship will be effective, the degree of hedge effectiveness must be tested on a prospective and retrospective basis. Rules likely to be revised in the near future. Embedded derivatives Existence potentially results in the entire contract being measured at fair value with changes in fair value recognised in the income statement. Generally not accounted for separately from the host contract. No requirement to measure the entire contract at fair value if they are present. Existence potentially results in the embedded derivative having to be accounted for separately at fair value. Index-linked debt Unclear whether these are to be treated as basic instruments (no change from current UK GAAP) or non-basic instruments (measured at fair value with changes in fair value recognised in the income statement). Debt contract recognised at amortised cost, with effect on interest or capital arising through changes in inflation reflected in the year of change. Depends on facts and circumstances and judgements made. Often treated in same way as UK GAAP, although sometimes the fair value of the indexlinked component required to be accounted for separately from the host debt contract as an ‘embedded derivative’ at fair value, with changes in fair value of that component recognised in the income statement. DERIVATIVES AND HEDGE ACCOUNTING Derivative instruments are not classified as ‘basic’ financial instruments under FRS 102 and are therefore always measured at fair value in the balance sheet. The approach known as ‘synthetic accounting’ used in UK GAAP (where, say, a variable rate loan and a floating-to-fixed rate swap are combined for accounting purposes and treated as a single fixed rate loan) is not permitted. Instead the hedging instrument and hedged contract must be accounted for separately. It is possible to achieve a similar income statement effect under FRS 102 as is achieved under UK GAAP (‘hedge accounting’), but it is necessary to adhere to certain procedures and processes. In such circumstances the volatility arising from changes in fair value of the derivative is dealt with as an item of other comprehensive income rather than recognised in the income statement. Where hedge accounting is not applied, then all changes in the fair value of derivatives are recognised in the income statement. EMBEDDED DERIVATIVES The existence of certain contract clauses that cause the cash flows of a contract, including a debt, purchase or sale contract, to behave in part like a derivative could also result in that contract failing to meet the conditions needed to be classified as a basic financial instrument within the scope of section 11. Although not a term used in FRS 102, these clauses are sometimes referred to as ‘embedded derivatives’. Their presence could result in the whole contract being subject to fair value accounting, ie remeasured to fair value at each reporting date with changes in fair value reported in the income statement. In addition, any contract for the supply of goods and services that imposes risks on either party to the contract that are not typical of such contracts might cause that contract to be subject to fair value accounting. Although most PBEs have probably not entered into contracts with features that would result in the entire contract having to be measured at fair value, auditors might still want to see evidence that organisations can demonstrate this is the case for contracts in place. INDEX-LINKED DEBT One type of loan finance commonly taken out by RPs is index-linked debt. To date, it has been thought that such loan contracts breach the conditions for being treated as basic instruments and therefore fall to be accounted for at fair value at each balance sheet date with changes in fair value reported in the income statement. Indeed, this is what supplementary guidance issued with the IFRS for SMEs (on which FRS 102 is based) indicates. However, more recently approved rules in IFRS 9 Financial Instruments (the full IFRS standard applicable from 1 January 2015) indicates that perhaps they can be considered as basic instruments after all. Similar considerations apply to an RP's index-linked homebuy loan receivables. It remains to be seen how this part of FRS 102 will be interpreted in relation to index-linked instruments or whether the revised housing SORP will set out a specific treatment. Clearly most RPs would not, however, want such contracts to be accounted for at fair value. 13 14 BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES SUMMARY 13. INVENTORY As with the proposals in FRED 48, FRS 102 contains a requirement to measure donated stock at fair value on receipt. However, this is caveated by stating that such items should only be recognised if they can be measured reliably. Furthermore, the concepts of materiality and cost/benefit should be considered when deciding which donated items should be recognised. It is likely, therefore, that most charities engaged in retail operations will argue on either or both of these grounds for not recognising unsold donated stock at the balance sheet date, with the effect that there will be no change to current accounting practice. However, when it comes to donated goods held for distribution as part of a charity’s activities there may be a significant change. This is discussed further in section 23 below. SUMMARY Issue FRS 102 Current UK GAAP and SORPs EU endorsed IFRS Donated goods held for resale Recognise if fair value can be reliably measured and benefits of recognising at fair value outweigh associated costs. Not recognised, with income arising only on sale of the goods received. Not addressed. Donated goods held for distribution Recognise if fair value can be reliably measured and benefits of recognising at fair value outweigh associated costs. Not recognised. Not addressed. 14. INVESTMENTS IN ASSOCIATES (CONSOLIDATED FINANCIAL STATEMENTS) The key area of difference identified is that under current UK GAAP (FRS 9 Associates and joint ventures) the share of associates’ losses must be recognised in full, even if it results in the investment in associate being presented as a net liability in the balance sheet. This contrasts with FRS 102 where the share of losses in excess of the cost of investment would not be recognised unless the investor has a legal or constructive obligation to make good those losses. Sometimes a not-for-profit entity may have entered into arrangements which enable it to exert significant influence over another entity (say through representation on the board), but because of the nature of the “investee” there isn't any equity stake taken, most likely because it may be a charity or company limited by guarantee such that economic returns do not attach to any equity instruments in issue. The revised SORPs could usefully provide guidance on the accounting for such entities over which significant influence is exerted, but where the economic benefits (if any) from exerting that influence are generated indirectly rather than directly through an underlying equity stake. Issue FRS 102 Current UK GAAP and SORPs Share of losses No recognition of Share of all losses share of losses in recognised. excess of cost of investment except if an obligation exists to make good those losses. EU endorsed IFRS No recognition of share of losses in excess of cost of investment except if an obligation exists to make good those losses. 15. INVESTMENTS IN JOINT VENTURES (CONSOLIDATED FINANCIAL STATEMENTS) Current UK GAAP (FRS 9 Associates and joint ventures) identifies two types of joint venture activity. The first, joint ventures (JVs), are accounted for using the gross equity method in an investor’s consolidated accounts. The second type of arrangement identified by FRS 9 is a joint arrangement that is not an entity (JANE). JANEs are distinguished from JVs in that the former do not carry on a trade or business of their own, rather are more like a cost- or risk-sharing means of carrying out a process in the participants’ trades or businesses. The acronym JANE is arguably a misnomer as some arrangements need to be accounted for as a JANE even though a separate entity may have been legally constituted. JANEs are typically found in property development activities of RPs and shared activities in HEIs. FRS 9 requires an investor to account directly for their own assets, liabilities and cash flows rather than a share of profits, as this better reflects the substance of the arrangement. FRS 102, by contrast, identifies three different types of joint venture arrangements: jointly controlled entities (JCEs), jointly controlled operations (JCOs) and jointly controlled assets (JCAs). The difference with current UK GAAP is that anything constituted as a separate legal entity must be accounted for as a JCE, even if the substance of the arrangement is such that it does not carry on a trade or business of its own. Furthermore, JCEs are accounted for under the equity method – the concept of gross equity accounting does not exist in FRS 102. The accounting requirements for JCOs and JCAs are similar to those for JANEs, save that the classification as JCO or JCA is driven by the absence of a separate legal entity rather than the absence of a trade or business distinct from the venturers. As with the accounting for associates, current UK GAAP requires the share of JVs’ losses in excess of cost to be recognised, even if it results in a net liability in the balance sheet. This contrasts with FRS 102 where the share of JCEs’ losses in excess of cost would generally not be recognised. BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES SUMMARY DEFINITION OF INVESTMENT PROPERTY Issue FRS 102 Current UK GAAP and SORPs EU endorsed IFRS Types of arrangement Distinction made between JCEs, JCAs and JCOs. Distinction made between JVs and JANEs. Distinction made between JCEs, JCAs and JCOs (periods beginning on or before 31 December 2012) and between joint ventures and joint operations (periods beginning on or after 1 January 2013). Accounting principle Basis of Accounting Share of losses 15 Classification of JCA or JCO only possible if the arrangement does not involve the creation of a separate legal entity. Classification based on substance of arrangement. Classification based on legal form (periods beginning on or before 31 December 2012) and based on substance of arrangement (periods beginning on or after 1 January 2013). Equity method for JCEs; account directly for underlying transactions of JCOs and JCAs. Gross equity method for JVs; account directly for underlying transactions of JANEs. Pre 2013: proportional consolidation or equity method for JCEs; account directly for underlying transactions of JCOs and JCAs. Post 2013: distinguishes between joint ventures (equity account) and joint operations (account directly for underlying transactions). No recognition of Share of all losses JCEs’ share of recognised. losses in excess of cost of investment. No recognition of JCEs’ (pre 2013) or JVs' (post 2013) share of losses in excess of cost of investment. 16. INVESTMENT PROPERTY MEASUREMENT BASIS As with UK GAAP (SSAP 19 Accounting for investment properties), investment properties are measured at fair value under FRS 102. However an option to account for investment property at depreciated cost is also available if revaluation would entail undue cost or effort. It remains to be seen how ‘undue cost or effort’ will be interpreted and, therefore, whether many entities will avail themselves of this option. The development of the past housing SORPs involved considerable debate over whether social housing properties should be classified as investment property under SSAP 19 or owner-occupied property under FRS 15 Tangible fixed assets. The conclusion reached was the latter on the basis that the primary purpose of the properties is the provision of social housing rather than to earn rentals. FRS 102 similarly proposes that properties held for the primary provision of social benefits will be accounted for as owner-occupied, rather than as investment, property. While this may come as a relief to those who would not have wanted to incur the expense associated with annual revaluations of investment property, there are perhaps two other key considerations: n Given that RPs’ new lettings and re-lets could result in up to 80% of the full market rent being charged, it becomes less clear that the primary purpose of all social housing properties owned by RPs is the provision of social benefits. Therefore, for some properties at least, the debate may still be open as to whether they should be accounted for as investment property. This is an issue on which the replacement housing SORP could usefully give further clarification n There are some very significant changes being considered by the IASB to the leasing standard in full IFRS which would be relevant to any RP choosing (or able) to apply that accounting framework. How the accounting for social housing properties would be affected in their capcacity as lessors of property, plant and equipment remains unclear. Whether any changes to full IFRS on the accounting for leases by lessors is incorporated into FRS 102 in the future similarly remains unclear. PROPERTIES RENTED TO OTHER MEMBERS OF THE SAME GROUP SSAP 19 specifically precludes properties rented to other members of the same group from being accounted for as investment property. The definition in FRS 102 contains no such exception, resulting in properties rented to other group members having to be accounted for as investment property in the individual accounts of the entity concerned. This might be one area in which it would be valid to claim that applying fair value causes undue cost or effort. This is because any such valuation movements would have to be reversed on consolidation given that from a consolidated perspective the property would be classified as owner occupied to which a policy of cost must be applied. ACCOUNTING FOR CHANGES IN FAIR VALUE Where investment properties are measured at fair value, FRS 102 requires gains and losses to be reported in the income statement. Charities currently present such gains and losses in the bottom part of the SOFA and other not-for-profit entities recognise them in the statement of total recognised gains and losses. LEASEHOLD INVESTMENT PROPERTY If leasehold property is held as investment property, under UK GAAP it is often valued on the basis of net rentals receivable. FRS 102 requires gross presentation with the value of the leasehold interest being presented as an asset and revalued each year, with the liability to pay rent on the head lease accounted for separately as a finance lease obligation measured at amortised cost. 16 BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES MIXED USE PROPERTIES FRS 102 requires an entity to account for a property that is both rented to others (ie investment property) and occupied for own purposes to be accounted for separately. Under current UK GAAP most entities would account for the property as either investment property or owner occupied (but not both) based on the preponderance of use. This is considered further in Section 17 below. SUMMARY Issue FRS 102 Classification Not classified as of social investment housing property. properties Changes in fair value Current UK GAAP and SORPs EU endorsed IFRS Not classified as investment property. Not addressed. Recognised in the Recognised in Recognised in the income statement. statement of total income statement. recognised gains and losses (or bottom half of SOFA). FRS 102, however, requires mixed use properties to be split into their respective components and accounted for separately. The only basis for not doing such a split, other than materiality, is that to attempt a revaluation of the portion held for investment would give rise to ‘undue cost or effort’. REVALUATION MODEL As with FRS 15 Tangible fixed assets, FRS 102 permits classes of tangible fixed assets to be measured at valuation or depreciated cost. The guidance in FRS 102 on the revaluation model is much less extensive than that contained in FRS 15 with the key differences being it: n sets no minimum requirements as to the frequency of revaluation, only that revaluations should be undertaken sufficiently frequently to ensure the carrying amount does not differ materially from the balance sheet date fair value. FRS 15, by contrast, requires a valuation every five years with an interim valuation undertaken in the third year of every five year cycle n requires valuations to be on the basis of fair value, rather than the FRS 15 bases of existing use value (EUV) and depreciated replacement cost for non-specialised properties and specialised properties respectively. Fair value is defined by reference to what price a willing buyer would pay in an orderly market transaction. HERITAGE ASSETS Properties rented to other group entities Subject to costbenefit considerations, accounted for as investment property in individual accounts and property, plant and equipment in group accounts. Classified as owner-occupied property in both the individual and group accounts. Accounted for as investment property in individual accounts and property, plant and equipment in group accounts. The requirements of FRS 102 are derived from the requirements of current UK GAAP (FRS 30 Heritage assets). FRS 102 is clear that an item is only a heritage asset if it is maintained principally for its contribution to knowledge and culture. Historic buildings that are used, for example, by education establishments as part of their operations would not be heritage assets. Similarly, works of art that are used to adorn walls for aesthetic appearance only would not be classed as heritage assets. An entity may, of course, consider it appropriate to provide additional information about such assets similar to that which would be provided for heritage assets. Leasehold investment property Account separately for gross value of property interest and obligations payable on the head lease. Usually account Account for the net separately for leasehold interest. gross value of property interest and obligations payable on the head lease. Consequently, no significant difference has been identified in the accounting for heritage assets between current UK GAAP and FRS 102, save that the latter requires separate presentation of heritage assets on the face of the balance sheet. However, the charity SORP also relates the classification of an asset as a heritage asset back to an entity’s objects. FRS 102 does not include such a requirement, and so it will be interesting to see if this link to an entity's objects is retained in the revised charity SORP. 17. PROPERTY, PLANT AND EQUIPMENT MIXED USE PROPERTIES Some entities own property that is partially occupied by the organisation for its own purposes and partially rented to third parties. Under current UK GAAP some entities apportion the property between an investment element and a non-investment element, accounting for the former as investment property and the latter as a tangible fixed asset. Indeed, the charity SORP requires this treatment if the components are clearly identifiable. The housing SORP is silent on the matter, with some choosing to account for properties as owner-occupied property even though there may be an investment property element (such as ground floor shops, doctor surgeries and community centres) on the basis that the property is predominantly used for social housing purposes and needed in providing amenities to the community served. The HE&FE SORP is similarly silent on the issue. LIBRARIES Some not-for-profit entities, most obviously education institutions, generally do not recognise an asset for libraries of books and periodicals. In jurisdictions which have already applied IFRS, some entities do account for such assets. Arguably, such items meet the definition of an asset under FRS 102 and, if material in aggregate, should be recognised. In many cases, considerable time and resource may be needed to obtain the depreciated cost of libraries. However, it may be possible, by analogy to look to the accounting for donated goods (see section 13), which does not require recognition of such assets when the cost of preparing the information outweighs the benefits to be received. The accounting for libraries may be an area which will be addressed in the revised HE&FE SORP. BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES STOCK TRANSFERS SUMMARY RPs occasionally exchange housing stock with each other, often to ensure the location of the properties owned match with their respective geographical area of expertise. There is little guidance at the moment on how to account for such transactions, and so this may be something the revised housing SORP could consider. There are probably 2 key considerations: n Firstly, the amount at which the properties transferred in should be recognised. On the one hand, on a historical cost basis, arguably their cost is the same as the net book value of the properties transferred out. By contrast, and perhaps more in line with the accounting for other exchange transactions covered in FRS 102, their deemed cost should be their fair value on receipt. This would give rise to a profit or loss based on the difference between the fair value of the properties received and the net book value of the properties transferred out. n Secondly, how to deal with SHG attaching to such properties, specifically whether it is also transferred between the RPs and separately recognised as SHG in the recipient RP. This is more of a legal issue governed by the original award of the grant and/or the specific terms of the exchange contract than an accounting one, and the accounting should simply follow the underlying legal analysis. SUMMARY Issue FRS 102 17 Current UK GAAP and SORPs EU endorsed IFRS Revaluation basis Fair value. Existing use value. Fair value. Mixed use property Account for owneroccupied and investment portions separately. Split accounting permitted, or alternatively account for entire property based on the predominance of use. Account for owneroccupied and investment portions separately. Heritage assets Presented as a separate class of asset on the face of the balance sheet. Subsumed within tangible fixed assets on the face of the balance sheet. Accounting for heritage assets not addressed. Issue FRS 102 Current UK GAAP and SORPs EU endorsed IFRS) Intangibles identified on acquisitions and insubstance gifts Initially recognised at fair value whether or not recognised in the acquiree’s balance sheet. Thereafter amortised over estimated useful economic life. Usually subsumed within goodwill. Initially recognised at fair value whether or not recognised in the acquiree’s balance sheet. Thereafter amortised over estimated useful economic life. Useful economic lives Presumed to be 5 years if they cannot otherwise be reliably estimated. Intangible assets with indefinite useful economic lives or lives in excess of 20 years are subject to impairment testing. Intangible assets with indefinite useful economic lives are subject to impairment testing. 19. BUSINESS COMBINATIONS AND GOODWILL FRS 102 identifies three types of combination that a PBE may enter into: n Acquisitions n Combinations which are in substance a gift n Mergers For any entity that does not meet the definition of a PBE, business combinations must be accounted for as acquisitions unless the combining entities are under common control, such as group reorganisation situations. ACQUISITIONS 18. INTANGIBLE ASSETS Broadly, the accounting for intangible assets under FRS 102 is the same as current UK GAAP. Notable differences are: n Certain combinations of PBEs could result in the recognition of intangible assets separate from goodwill in the financial statements of the acquirer. These intangibles would then be amortised over their estimated useful economic lives. This is discussed further in Section 19 below. n Where they cannot be reliably estimated, intangible assets are presumed to have a useful economic life of 5 years The acquisition method of accounting will apply to situations where one entity has taken over another in an arm’s length transaction for valuable consideration. Such transactions do occur in the not-for profit sector and require the acquiree’s identifiable assets and liabilities to be subject to a fair value exercise. Under the acquisition method the acquiree’s income and expenditure is only incorporated into the acquirer’s consolidated income statement from the date of the combination. The excess of any consideration paid over the net fair value of the identifiable assets, liabilities and contingent liabilities acquired is classified as goodwill and is depreciated over its useful economic life. If an entity is unable to make a reliable estimate of its useful economic life, it is amortised over five years. Although not recognised in their balance sheet, much of an acquiree’s value might relate to intangible assets (brand names, logos, copyrights, inherent contract value, etc).When accounting for an acquisition under FRS 102, it is likely that more of an acquiree’s intangibles would be recognised on consolidation than is the case under current UK GAAP. There are three reasons for this: n Current UK GAAP only permits intangibles to be recognised where they are separable (ie can be disposed of separately without disposing of the acquired entity’s business). FRS 102 contains no such restriction 18 BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES n FRS 102 asserts that ‘An intangible asset acquired in a business combination is normally recognised as an asset because its fair value can be measured with sufficient reliability’. By contrast, current UK GAAP implies that only entities regularly engaged in the purchase of unique intangibles are likely to be able to measure such intangibles with sufficient reliability n Current UK GAAP does not permit the amount of any negative goodwill arising on acquisition to be increased through the recognition of intangible assets. FRS 102, however, contains no such restriction. If an intangible asset has been identified then, assuming it can be measured reliably, it should be recognised on acquisition at fair value even if it creates or increases negative goodwill. It could be a mistake to assume that in an entity combination involving PBEs there is no value to recognise in relation to the intangibles of the entity identified as the acquiree (in an acquisition) or the donor entity (an in-substance gift – see opposite). A decision to mothball intangibles such as brands and logos post combination would give rise to a post combination impairment of such assets rather than attributing them with a fair value of nil on the date of acquisition. Due to the requirement to recognise various intangible assets separately, the amount attributable to goodwill generally represents the value of the acquiree's assembled workforce and expected synergistic benefits arising from the acquisition. These items do not meet the criteria for recognition as separate intangible assets under FRS 102. Under current UK GAAP (FRS 10 Goodwill and intangible assets) and FRS 102, negative goodwill up to the fair value of the non-monetary assets acquired is recognised in the income statement in the periods in which the non-monetary assets are recovered, whether through depreciation or sale. Any negative goodwill in excess of the fair values of the non-monetary assets acquired is recognised in the income statement in the periods expected to benefit. Full IFRS, by contrast, does not permit negative goodwill to be carried forward in the balance sheet. Rather it requires the immediate recognition of a gain in the income statement. MERGERS Under FRS 102, only a combination involving PBEs can be accounted for using the merger method of accounting. For a combination to be classified as a merger, all of the following criteria must be met: n no party to the combination is portrayed as either acquirer or acquiree, either by its own board or management or by that of another party to the combination n there is no significant change to the class of beneficiaries of the combining entities or the benefits provided as a result of the combination n all parties to the combination, as represented by the members of the board, participate in establishing the management structure of the combined entity and in selecting the management personnel, and such decisions are made on the basis of a consensus between the parties to the combination rather than purely by exercise of voting rights. The criteria in FRS 6 Acquisitions and mergers concerning the relative sizes of the combining entities has not been carried forward into FRS 102 and has instead been replaced by an assessment of whether there has been a significant change to the beneficiaries of the combining entities. The accounting for mergers is unchanged from that set out in FRS 6 and requires book values (as adjusted to ensure uniformity of accounting policies) rather than fair values of the combining entities be used in preparing the enlarged group’s financial statements. Comparatives are presented as if the two combining entities had always formed a single reporting entity, although FRS 102 contains an explicit requirement that such comparatives be headed up as ‘combined’ on the grounds that the merged reporting entity did not exist in the comparative period and that the comparative numbers reported are a combination of previously reported figures for the merging entities. COMBINATIONS WHICH ARE IN SUBSTANCE GIFTS Some combinations do not meet the conditions to be classified as a merger, and at the same time acquisition accounting might also not be appropriate due to the absence of any consideration paid in effecting the combination. Where this is the case, the combination might in substance be indistinguishable from a gift by one entity of its assets to another. In such combinations FRS 102 requires the receiving entity to measure the assets received (including intangibles if they can be measured reliably) and liabilities assumed at their fair value, with the net amount recognised as a gain in the income statement. The housing SORP Update 2010 introduced a similar treatment for accounting periods beginning on or after 1 April 2011 as did the charity SORP Information Sheet 2. FRS 102 notes that except for treating the fair value of assets received as a gift, all other aspects of the transaction should be accounted for as an acquisition. Consequently it would seem that the receiving entity should similarly recognise all intangible and heritage assets received in such combinations at fair value, irrespective of whether such assets were recognised in the balance sheet of the donor entity. BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES 20. LEASES SUMMARY Issue 19 FRS 102 Direct costs Capitalised. of acquisition Current UK GAAP and SORPs EU endorsed IFRS Capitalised. Expensed. Under FRS 102 the broad approach to classifying leases as finance or operating is the same as current UK GAAP (SSAP 21 Accounting for leases and hire purchase contracts). There are, however, some areas of potential difference in the detail that could affect some not-for-profit entities. LEASEHOLD PREMIUMS PAID Goodwill Unless it can be Default life of 20 estimated reliably, years generally useful economic used. life is limited to 5 years. Goodwill not amortised, rather subject to mandatory annual impairment review. Negative goodwill Negative goodwill deferred in balance sheet and released to income statement over appropriate periods. Credited immediately to income statement in full. Negative goodwill deferred in balance sheet and released to income statement over appropriate periods. Prior to housing SORP Update 2010 RPs recognised negative goodwill in reserves, although for periods after 1 April 2011 generally credited in full direct to I&E if a non-exchange transaction. OPERATING LEASE INCENTIVES FRS 102 requires lease incentives to be spread over the lease term, which will generally be to the first break clause (if any) unless it is reasonably certain at inception of the lease that the break clause will not be exercised. This contrasts with current UK GAAP, which spreads lease incentives over the period to the first market rent review. Therefore, only when the first rent review coincides with the first break clause in a lease will there generally be no difference between current UK GAAP and FRS 102. This change could be significant for any PBE that rents a large number of commercial properties, eg charities with retail operations. ARRANGEMENTS THAT CONTAIN A LEASE Merger accounting Permitted for PBEs Permitted. and common control transactions. Not permitted. Combination that is in substance a gift Identified and permitted. Not addressed. Intangibles identified on acquisitions and combinations that are in substance gifts Initially recognised Usually subsumed at fair value within goodwill. whether or not recognised in the acquiree’s balance sheet. Thereafter amortised over estimated useful economic life (or over 5 years if the useful economic life cannot be reliably estimated). Identified and permitted by Housing SORP Update 2010 and Charity SORP Information Sheet 2. Under current UK GAAP leasehold premiums are normally presented as tangible fixed assets (namely the underlying property interest acquired) and depreciated over the lease term. On transition to full IFRS many listed entities presented such assets as prepayments of rent and so it might be expected that a similar approach will be taken under FRS 102. This also has the effect of reclassifying some of the leasehold premium balance as a current asset, ie the portion that will be expensed in the next accounting period. Initially recognised at fair value whether or not recognised in the acquiree’s balance sheet. Thereafter amortised over estimated useful economic life. FRS 102 contains guidance borrowed from full IFRS on whether certain arrangements, although not in the legal form of a lease, nonetheless convey the rights to use of an asset in return for payments in the same way as a lease. Typically, they may be found in some outsourcing arrangements. The payments made and the length of the contract mean that assets used to service a contract by a supplier are to all intents and purposes transferred to the customer as if they were leased, only as part of a much wider service contract. In such circumstances it might be necessary for lease liabilities and leased assets to be recognised on inception of the arrangement, with judgement needed to be applied to determine how much of the overall contract payment is in substance lease payments. Types of arrangements this may affect are catering and IT contracts whereby the contract price covers the cost of specific equipment installed by the third party supplier to provide the contracted services. DISCLOSURE For lessees FRS 102 requires the total future minimum lease commitments to be disclosed, analysed by when the leases expire. By contrast, current UK GAAP requires disclosure of the annual lease commitment, analysed by when the lease expires. In this respect, FRS 102 provides information on the total off-balance sheet finance obtained through operating leases as opposed to the approach in current UK GAAP of focussing on the future annual expense and cash outflow. 20 BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES Entities may also find that they are caught by disclosures in their capacity as lessor, which are more extensive than are required under current UK GAAP. In addition to a general description of significant leasing arrangements FRS 102 requires a maturity analysis of the total future minimum lease payments receivable to be disclosed, effectively the equal and opposite disclosure that lessees must provide. This could affect RPs in particular, where there is a minimum future rental due under noncancellable tenancy agreements. REVISIONS MADE TO PROPOSALS IN FRED 48 FRS 102 contains the requirements outlined above for operating lease incentives and arrangements that contain a lease. FRED 48 was silent on these matters. SUMMARY Issue FRS 102 Current UK GAAP and SORPs EU endorsed IFRS Leasehold premiums paid Leasehold premiums paid likely to be classified as prepayments. Leasehold premiums paid generally classified as a property asset. Leasehold premiums paid classified as prepayments. Spread over the lease term. Spread over the Spread over the period to first rent lease term. review. Lease incentives Arrangements Potential need to Not addressed. that contain account for leases a lease embedded into other contracts. Potential need to account for leases embedded into other contracts. Disclosure of operating lease commitments Disclosure required of the total future minimum lease commitment. Disclosure required of the annual lease commitment. Disclosure required of the total future minimum lease commitment. Disclosure of operating lease receivables Disclosure required of the total future minimum lease receivable. Disclosure of aggregate rentals receivable in the period. Disclosure required of the total future minimum lease receivable. 21. PROVISIONS AND CONTINGENCIES GENERAL The general principles in FRS 102 for the accounting for provisions and contingencies are very similar to UK GAAP (FRS 12 Provisions, contingent liabilities and assets) and therefore one might not expect many changes in this area. FUNDING COMMITMENTS FRS 102 contains separate accounting rules dealing with funding commitments. The term ‘funding commitment’ is not defined, but applies when an entity has committed to provide resources (except for loan commitments) to other entities and would therefore seem to be directly applicable to grant-making entities. ‘Entity’ as used in the context of the recipient would seem to include individuals. FRS 102 notes that funding commitments will only be recognised as a liability when: n the definition and recognition criteria for a liability have been satisfied; n the obligation (which may be a constructive obligation) is such that the entity cannot realistically withdraw from it; and n the entitlement of the other party to the resources does not depend on the satisfaction of performance-related conditions (as defined). Commitments that are subject to performance-related conditions (see section 23) would only be recognised as those conditions are satisfied. It is noted in this context that a restriction on the manner in which funds are to be spent does not constitute a performance-related condition. Therefore the existence of restrictions would not preclude recognition of a liability. However, in order to recognise a liability it is necessary to have communicated that commitment to the intended recipient. A general statement of intent to provide resources to certain classes of beneficiaries in accordance with its objectives does not give rise to the recognition of a funding liability. Similarly, a promise to provide cash conditional on the receipt of some future income does not necessarily give rise to a liability. Some entities may have entered into commitments that are in excess of available funds such that recognition of the commitment would give rise to overall net liabilities. In such situations it seems clear that the ability to honour such commitments are in turn dependent on future income and should, therefore, not be recognised. In addition, FRS 102 makes it clear that the recognition of a funding commitment will generally give rise to an associated expense. Therefore it is not expected that the debit entry would be accounted for as an asset (such as a prepayment) on the grounds that the benefit to the grantor, or the recipient, accrues in a future period. It will be interesting to see if any of the revised SORPs identify any circumstances when recognition of a funding commitment would not give rise to an expense. REVISIONS MADE TO PROPOSALS IN FRED 48 Due to the way in which performance conditions and restrictions have been re-defined in FRS 102, the proposed accounting for funding commitments has been much improved. It has also been clarified that the recognition of a funding liability will usually give rise to an associated expense as opposed to some other asset to be expensed in future periods. There would now appear to be little difference between FRS 102 and current UK GAAP. In addition, the accounting for financial guarantees provided by most entities has been brought within the scope of the Section 21 as opposed to being accounted for as financial instruments within the scope of Sections 11 and 12. This makes the accounting much simpler than it might otherwise have been. BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES 21 22. LIABILITIES AND EQUITY ENDOWMENTS No significant areas of difference in the accounting for liabilities and equity under current UK GAAP as applied by PBEs have been identified. The accounting by education institutions for endowments looks likely to undergo a change. The HE&FE SORP requires institutions to categorise donations as either income or endowments. Donations classified as income are recognised in the I&E account, whereas donations classified as endowments are recognised in the statement of total recognised gains and losses. It is difficult to see how it would be possible under FRS 102 to classify the receipt of donations as an item of other comprehensive income, rather it would need to be presented within the income statement when it qualifies to be recognised. 23. REVENUE The accounting for revenue from commercial activities is unlikely to be affected on transition to FRS 102. However, it does include specific guidance for PBEs on the accounting for incoming resources from nonexchange transactions that will need to be considered. NON-EXCHANGE TRANSACTIONS A non-exchange transaction is defined as ‘a transaction whereby an entity receives value from another entity without directly giving approximately equal value in exchange, or gives value to another entity without directly receiving approximately equal value in exchange.’ Although defined in the context of both income and expenditure, FRS 102 only provides accounting guidance in respect of income from such transactions, identifying donations (of cash, goods or services) and legacies as a nonexhaustive list of examples. The accounting for non-exchange transactions would also apply to grant income received from parties other than government (see Section 24 below). INCOME FROM NON-EXCHANGE TRANSACTIONS SUBJECT TO PERFORMANCE CONDITIONS Income is not recognised from non-exchange transactions until performance-related conditions have been met, with a performancerelated condition defined as a 'condition that requires the performance of a particular level of service or units of output to be delivered, with payment of, or entitlement to, the resources conditional on that performance.' This is the same definition as used in conjunction with the accounting requirements for funding commitments (see Section 21 above), arguably a non-exchange transaction on the expenditure side although not specifically referred to as such. INCOME FROM NON-EXCHANGE TRANSACTIONS SUBJECT TO RESTRICTIONS The guidance on incoming resources from non-exchange transactions also addresses the accounting for income subject to a 'restriction', which is defined as ‘a requirement that limits or directs the purpose for which a resource may be used that does not meet the definition of a performance-related condition.' The existence of restrictions attaching to incoming resources does not prohibit income being recognised when the resource is receivable. Although this is consistent with the charity SORP, other not-for-profit entities may see an acceleration of revenue recognition. For example, a donation to a university for the construction of a new sports hall would not be recognised as income to match with the period the sports hall is either built or depreciated. This is because the requirement to build a sports hall would only constitute a restriction and not a performance-related condition. This analysis is, however, subject to the income not being classified as a government grant (see section 24) for which a policy of matching income with expenditure is still permitted by FRS 102. Furthermore, endowments that are subject to restrictions would be recognised in the income statement in full once entitlement is established and receipt is probable. This would be the case even if the endowment is to be spent on the purchase of a long-term fixed asset, such as an item of property, plant or equipment. DONATED GOODS FRS 102 specifies that income from non-exchange transactions must only be recognised when the resource received can be measured reliably, taking into account whether the benefits to recognise the resource outweigh the costs. It notes that the most common example is that of high volume, low value second-hand goods donated for sale. In such circumstances the income will be recognised when sold, as is commonly the case under current UK GAAP. However, FRS 102 does not prohibit an entity from undertaking such a valuation exercise and recognising an asset for donated goods accordingly. Where goods are donated for charitable use (eg food aid for onward distribution) rather than specifically for sale, such assets would also be required to be recognised at fair value subject to being capable of reliable measurement and the benefits of recognition outweighing the associated cost. Where the assets are subject to performance conditions , then it would seem necessary to recognise both the asset and deferred income. The difficulty comes in determining what the entity would otherwise have purchased. Furthermore, it would appear that FRS 102 requires recognition at the fair value of the items received, not the fair value of the goods which would otherwise have been bought had they not been donated. Such accounting would represent a significant change from current UK GAAP, which would only reflect income and expense at the point the donated goods were transferred for the use of the intended beneficiaries measured at the deemed value to the entity. DONATED SERVICES AND VOLUNTEER TIME FRS 102 requires the recognition of donated services if their value can be reasonably quantified. It further states that donated services that can be reasonably quantified include facilities such as office accommodation, services provided as part of a trade or profession and services that would otherwise have been purchased by the entity had they not been donated. As the current charity SORP contains similar requirements there is unlikely to be a change in the accounting for donated services. FRS 102 also states that ‘it is expected that contributions made by volunteers cannot be reasonably quantified, therefore these services shall not be recognised’. As with the current charity SORP requirements, it might be expected that volunteer time will not be recognised as a result of this guidance. However, the wording used is arguably not categorical in prohibiting recognition of volunteer time. It will be interesting to see whether any entity will argue that volunteer time can be reliably measured and therefore recognise it as income in the financial statements, or whether any of the revised SORPs will be more explicit in prohibiting the recognition of volunteer services. 22 BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES 24. GOVERNMENT GRANTS LEGACIES Under FRS 102 a legacy is recognised when it is probable that the legacy will be received and its value can be measured with sufficient reliability. It states that this will usually be the case following probate once the executor of the estate has established there will be sufficient funds to pay the legacy. It further states that evidence the executor has determined a payment can be made may arise on agreement of the estate’s accounts or notification that payment will be made. Of course, an executor must produce a statement of account in order to obtain probate (at least in the UK) and so arguably it is not entirely clear how this links in to the principle of recognising the income when it is probable it will be received. In many cases there may be very little doubt as to either the legitimacy of a will or the sufficiency of funds in an estate to pay a legacy on the death of a legator. Arguably, therefore, the legacy should be recognised closer to death in such circumstances because receipt is probable, albeit not immediately receivable due to the probate process. The current charity SORP requires legacies to be recognised when the income is reasonably certain, which appears to impute a higher threshold for income / asset recognition than contained in the principles of FRS 102. It will therefore be interesting to see whether the revised SORP is updated in any way for legacy income recognition or provides additional, more specific guidance, on the appropriate timing of recognising income from legacies. REVISIONS MADE TO PROPOSALS IN FRED 48 Revisions have been made to the definitions of both 'performancerelated condition' and 'restrictions' that could significantly impact not only the timing of recognition compared to the proposals in FRED 48, but also compared with current UK GAAP for some entities. SUMMARY DISTINCTION BETWEEN GRANTS AND NON-EXCHANGE TRANSACTIONS A government grant is defined as ‘assistance by government in the form of transfers of resources to an entity in return for past or future compliance with certain conditions relating to the operating activities of the entity. Government refers to government, government agencies and similar bodies whether local, national or international.’ This would appear to include bodies such as the United Nations, European Union, and the Homes and Communities Agency. Grants are accounted for under one of two models with the chosen model applied to all grants as an accounting policy choice: n the performance model, whereby income is recorded as performance conditions are met n the accrual model, which requires the grant to be classified as either relating to revenue expenditure or asset expenditure. Grants relating to revenue expenditure are recognised in income on a systematic basis over the periods in which the entity recognises the related costs for which the grant is intended to compensate. Grants relating to assets are recognised on a systematic basis over the expected useful life of the asset. The accrual model therefore matches the recognition of the grant in the income statement with the related expenditure. Grants that do not meet the definition of a government grant would have to be accounted for as a non-exchange transaction in accordance with Section 23, which only permits use of the performance model. With there being a clear distinction being made between the accounting for government grants and grants from others, some not-for-profit entities may see a significant shift in the basis on which non-government grants are recognised. SOCIAL HOUSING GRANT (SHG) Issue FRS 102 Current UK GAAP and SORPs EU endorsed IFRS Presentation of endowment income received by HE&FE institutions Receipt deferred in balance sheet if subject to ‘performance conditions’ otherwise recognised in the income statement. HE&FE SORP requires endowments to be recognised in the statement of total recognised gains and losses. Receipt of endowments recognised in the income statement. Recognition of restricted endowment income Recognised as income when receipt is probable and amount can be measured reliably. HEIs match Not addressed. recognition of income and expense in the I&E account. Donated assets held for distribution Recognised on receipt at actual fair value. Recognised on Not addressed. distribution at value to the entity. Volunteer time High hurdle recognition test. High hurdle recognition test. Not addressed. Legacies Littte guidance on the appropriate timing of recognition. Diversity in practice. Not addressed. Under the housing SORP, if the policy is to measure social housing properties at depreciated cost then SHG is netted against the cost of the acquired property or homebuy loan making use of a ‘linked presentation’ approach on the face of the balance sheet. Where a policy of revaluing social housing policies is applied, SHG is initially netted against the property, but on first revaluation of the property effectively gets wrapped up within the revaluation reserve. As with current accounting standards FRS 102 does not deal specifically with how to account for SHG. It will be left to the housing SORP to provide guidance by reference to the general principles in FRS 102. This looks like it could be a very challenging task and stems largely from one key difference between FRS 102 and current UK GAAP, namely that FRS 102 would seem to prohibit netting SHG against the assets being funded through the grant. Instead, SHG would need to be initially recorded as a separate balance on the balance sheet within creditors (if the accruals model is applied to government grants) or direct in income (if the performance model is applied). This latter treatment arises because SHG is arguably subject only to restrictions, namely to be used to fund housing, rather than subject to any performance-related conditions. As discussed above, the existence of restrictions does not preclude the recognition of income in the I&E account. Perhaps the first issue for the housing SORP working party to consider, therefore, is whether to mandate use of either the accruals model or the performance model to ensure the accounting for SHG is consistent across the RP sector. Whichever model an entity chooses (or the revised SORP mandates) there will be new accounting to get to grips with, conceptual challenges to overcome and a number of known unknowns. BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES 23 For example, under the accruals model: n Will SHG be allocated to the same components as under current UK GAAP, albeit presented separately on the balance sheet, or will it not be allocated to certain components? If SHG is not allocated to some components, then it is possible for immediate credits to income to arise if the amount of SHG is greater than components to which it can be allocated n The gross asset becomes depreciable, rather than the amount net of SHG. The I&E impact may be unchanged because there would be an equal release of SHG to the I&E account, but EBITDA would be affected n There could be a greater possibility of property impairments, perhaps immediately on purchase or construction, as the carrying amount of the assets (being gross of SHG) may be greater than the net present value of cash flows plus planned subsidy. Depending on which components SHG is allocated to, the amount of SHG to release may not match the amount of any impairment n What happens on a sale of a grant-funded property? Does SHG come back on balance sheet (perhaps as an adjustment to the profit on disposal) to be released as the replacement property is depreciated? After all, the SHG funds the replacement property as much as it funded the property sold. Alternatively, should SHG already released to I&E as the original property was depreciated remain in reserves? This is on the basis that the repayment of SHG is wholly within the control of the RP as long as it recycles the proceeds into a replacement property and consequently does not meet the definition of a liability under FRS 102 n If SHG is brought back onto the balance sheet as a separate creditor, guidance may be needed on the debit entry on transition to FRS 102 for those entities applying a policy of revaluation of social housing properties. Grossing up properties further wouldn’t seem to be appropriate as it would mean the revised carrying amount may be greater than fair value (the measurement basis for properties carried at valuation under FRS 102), giving rise to an immediate impairment. The performance model would appear not to give rise to the same complexities. Indeed, as noted above, it would appear the SHG is subject only to restrictions rather than performance conditions and so would be recognised in income on receipt. However, it would give rise to greater volatility in the I&E account as the RP would recognise large credits in the year SHG is received. This in turn results in larger depreciation charges on the gross carrying amount of the asset in subsequent periods. One argument to remove many, if not all, of the above complications arising on accounting for SHG under FRS 102 is to simply view it as an interest free loan. Arguably SHG is not grant in the same sense as most other grants given out by government in that it is ultimately always subject to repayment. This would mean that concessionary loan accounting could apply (see Section 11), with the effect that SHG remains on balance sheet as a liability until it is cancelled. Furthermore, as SHG is cancelled to the extent that sales proceeds on disposal are less than original cost, the residual value of a property is equal to the SHG meaning that the depreciable cost of properties is in turn equal to an amount net of SHG, ie the same as current UK GAAP. It would be interesting to know whether such an interpretation would be permissible under the revised housing SORP or, alternatively, the reasons why it would not be permissible. REVISIONS MADE TO PROPOSALS IN FRED 48 The choice of the performance and accruals model in FRED 48 applied to all grants, irrespective of whether the funds were coming from government bodies or others. This gave rise to problems of interpretation because it was not clear how a grant from a nongovernmental body could be distinguished from a non-exchange transaction (see section 23 above) for which there is no choice of accounting treatment (only the performance model is available). Although this problem has been fixed in FRS 102, the whole subject of accounting for grants may be subject to revision in the future as it is is difficult to see any conceptual reason why grant income is potentially accounted for differently depending on who has provided the funding. SUMMARY Issue FRS 102 Current UK GAAP and SORPs EU endorsed IFRS Accounting model Choice of performance model or accrual model. Charity SORP requires all grants to be recognised on receipt, except to the extent repayment is considered probable. Other not-for-profit entities apply matching concept to recognition of grants received in the income statement. Recognition of grant income in the income statement matched to the recognition as an expense of the related expenditure. SHG Likely to be presented separately from the related property. The implications under each of the performance and accrual models will likely be addressed in the revised housing SORP. Netted against the cost or value of the funded property, with depreciation charged on the net amount. Where a RP applies a policy of cost, the housing SORP requires a linked presentation on the face of the balance sheet. Presented separately from the related property. Subsequent accounting not addressed. 24 BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES 25. BORROWING COSTS No significant areas of difference in the accounting for liabilities and equity under current UK GAAP as applied by PBEs have been identified. 26. SHARE-BASED PAYMENT This section is unlikely to be of relevance to not-for-profit entities. The main difference is that on grounds of ‘undue cost or effort’ it is permissible to use directors’ valuation of instruments granted rather than performing a fair value exercise. The HE&FE SORP incorporates the term ‘income generating unit’ as used in FRS 11 to determine appropriate groupings of assets for carrying out impairment reviews. Although this will often be the same as a cash generating unit, the SORP notes that ‘as many income generating units should be identified as is reasonably practical’. This acknowledgement of ‘reasonably practical’ does not exist in FRS 102 and therefore might result in income generating units having to be broken down into more than one cash generating unit. SUMMARY Issue FRS 102 Current UK GAAP and SORPs Link to accounting for SHG To be clarified by new housing SORP. Amount of Income and impairment factors expense matched. in any SHG. 27. IMPAIRMENT OF ASSETS RECOVERABLE AMOUNT The broad approach to impairment under FRS 102 is the same as UK GAAP (FRS 11 Impairment of fixed assets and goodwill), ie impairments are recognised when the recoverable amount of an asset falls below its book value. Recoverable amount is in turn defined under both reporting frameworks as the higher of (i) net realisable value less costs to sell and (ii) the present value of cash flows generated from continued use of an asset (its ‘value in use’). Furthermore, as with current UK GAAP, FRS 102 acknowledges that a cash flow driven valuation may not be appropriate for assets held for their service potential. This is the case for many assets held by not-for-profit entities and therefore it suggests other approaches, such as depreciated replacement cost, may be used if more appropriate. Level at Individual asset or which cash generating impairment is unit level. carried out EU endorsed IFRS For RPs, assets are Individual asset or grouped according cash generating to the way they unit level. are managed in practice. 28. EMPLOYEE BENEFITS HOLIDAY PAY LINK TO SHG ACCOUNTING RPs have tended to assess recoverability of social housing properties by reference to the amount of inherent planned subsidy. However, the carrying amount of the asset tested for impairment under this approach is reduced by any associated SHG. The accounting adopted for SHG could, therefore, have a knock-on effect to the accounting for impairments. This is because if the gross carrying value of the property is now subject to impairment (as opposed to an amount net of any SHG), then this increases the recoverable amount of the property for impairment testing purposes. The property may now be impaired because the future cash flows plus the amount of planned subsidy could be less than the gross carrying value of the property. Under current UK GAAP it may not be impaired because it is less than the net carrying amount of the property (ie after deduction of SHG). Although the recognition of an impairment charge might be offset by a release of SHG, EBITDA could be affected which is an important consideration for RPs with EBITDA related loan covenants. Again, such issues will probably need to be addressed by the new housing SORP. LEVEL AT WHICH IMPAIRMENT IS TESTED In undertaking an impairment review FRS 102 requires individual assets to be reviewed for impairment to the extent their recoverable amount can be estimated. Where it is not possible to estimate the recoverable amount of individual assets, impairment reviews are carried out at the ‘cash generating unit’ level. This is the smallest group of assets that generate cash flows independently from other groups of assets. There could be significant implications for some RPs that, under the current SORP, group assets together for impairment review purposes based on the way they are managed in practice. This could either be on a scheme by scheme or a single portfolio basis. The replacement SORP may need to consider whether this approach is acceptable under FRS 102. As FRS 102 specifically refers to paid annual leave as a benefit given to employees, it is likely that entities would need to record accruals in respect of employees who have taken less than their accrued entitlement, or prepayments in respect of employees who have taken more than their accrued entitlement, at the balance sheet date. Such adjustments are rarely made under current UK GAAP. Nonetheless, some entities might be surprised at the size of the adjustment needed to their transition balance sheets, particularly if they permit employees to carry forward significant unused holiday or the holiday year does not coincide with the accounting period. Education institutions, for example, typically have a July accounting year-end but may have holiday years that are the same as a calendar year. Assuming many employees take the bulk of their annual leave entitlement in August this means that at the end of July the institution could have a significant accrual to account for, reducing net assets accordingly. DEFINED BENEFIT SCHEMES The accounting for defined benefit schemes under FRS 102 broadly follows the same principles as current UK GAAP (FRS 17 Retirement benefits). However, rather than recognising interest equal to the difference between the unwinding of the discount on scheme liabilities and the expected return on scheme assets (which is the approach in current UK GAAP), FRS 102 requires a net interest expense or income to be recognised based on the net deficit or surplus respectively in the scheme. This approach aligns with revisions made recently to full IFRS. There is no concept of a separate pension reserve in FRS 102 or full IFRS and therefore it might be expected that these will be subsumed within an entity’s retained surplus. BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES 25 MULTI EMPLOYER SCHEMES Current UK GAAP, FRS 102 and IFRSs all acknowledge the difficulties of applying defined benefit accounting to multi-employer schemes. They instead permit an entity to account for participation in such schemes as defined contribution schemes if it is not possible to identify its share of the underlying assets and liabilities of the scheme. The main difference, however, is the treatment applied to deficits where a plan has been agreed to fund an identified deficit. Where there is such an agreed deficit funding plan, FRS 102 requires a liability to be recognised for the present value of the contributions payable that arise from that agreement (to the extent that they relate to the deficit) with the resulting expense recognised in the income statement. This accounting is likely to give rise to much more volatility in the I&E account as deficit funding plans are revised with each triennial actuarial valuation, and previously assessed liabilities are increased or decreased. SUMMARY Issue FRS 102 Current UK GAAP and SORPs EU endorsed IFRS Holiday pay accruals Holiday pay to be recognised as an accrual or prepayment as appropriate. Accrued and prepaid holiday pay generally not accounted for. Holiday pay to be recognised as an accrual or prepayment as appropriate. Presentation of actuarial gains and losses Actuarial gains and losses recognised as an item of other comprehensive income. Actuarial gains and losses recognised in the statement of total recognised gains and losses (or for charities in bottom part of SOFA). Actuarial gains and losses recognised as an item of other comprehensive income. Interest income/ expense on DB schemes Present a net interest income/expense based on opening surplus/deficit position. Net finance cost equal to difference between unwinding of discount on scheme liabilities, and expected return on scheme assets. Present a net interest income/expense based on opening surplus/deficit position. Presentation of a separate pension reserve No concept of a separate reserve. Required by HE&FE and charity SORPs. No concept of a separate reserve. Agreements to fund multiemployer scheme deficits Liability recognised. Not specifically Liability addressed, recognised. possible divergence in practice, although liability generally not recognised by entities. Group schemes Where assets and liabilities of scheme cannot be apportioned to individual group entities, the entity legally responsible for the plan is required to reflect the full cost. Usually accounted for as multiemployer schemes by all group entities. GROUP SCHEMES Many group schemes are also run on a basis that does not enable individual entities in the group to identify their share of the underlying assets and liabilities of that scheme. Although the consolidated financial statements would reflect the full surplus or deficit in the scheme, each participating entity is able to account for the scheme as a defined contribution scheme under current UK GAAP. Under current UK GAAP, however, there is only a requirement to allocate scheme assets and liabilities to individual group entities (including the parent) when it is possible to do so. Under FRS 102, an absence of an agreed method of allocating surpluses and deficits between group entities results in the sponsoring entity (usually the parent) having to recognise the scheme surplus or deficit in full in its individual financial statements. In other words, defined benefit scheme accounting under FRS 102 always applies in at least one group entity's financial statements as well as the consolidated financial statements. REVISIONS MADE TO PROPOSALS IN FRED 48 Two key changes have been made to the proposals contained in FRED 48. Firstly, FRED 48 permitted certain simplifications to the calculation of a defined benefit obligation where the projected unit credit method caused an entity 'undue cost or effort'. This concession has been removed in FRS 102 to be consistent with both current UK GAAP and full IFRS, neither of which permit any such simplification. Secondly, as noted above, FRS 102 requires a liability to be recognised for agreements in place to fund scheme deficits of multi-employer schemes, a requirement that was not in FRED 48. Where assets and liabilities of scheme cannot be apportioned to individual group entities, the entity legally responsible for the plan is required to reflect the full cost. 26 BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES 29. INCOME TAX 30. FOREIGN CURRENCY CURRENT TAX Charitable entities that have corporate trading subsidiaries usually apply gift aid to the taxable profits otherwise arising in the trading entity, resulting in no current tax liability. There is nothing to suggest that the accounting will be any different for financial statements prepared in accordance with FRS 102. However, these corporate subsidiaries could have new accounting treatments to apply, which could result in the restatement of prior periods’ accounting profits. Depending on how the profit restatements arise there could be current tax implications for companies using gift aid to manage their tax position. DEFERRED TAX The accounting for deferred tax in FRS 102 follows the ‘timing difference plus’ approach, which recognises deferred tax to the extent that gains and losses are recognised in a different period to which they are taxed. Although current UK GAAP (FRS 19 Deferred tax) also adopts a timing difference approach there are some key differences, notably that FRS 102 requires deferred tax to be recognised on asset revaluations and the recognition of new assets (such as intangibles) and fair value adjustments on business combinations. None of the SORPs currently address deferred tax in any great detail. It will be interesting to see if greater detail is given in the revised SORPs. SUMMARY Issue FRS 102 Current UK GAAP and SORPs EU endorsed IFRS n/a Arises due to restatement of prior periods’ taxable profits, which may be difficult to manage using gift aid. Current tax issues arising on transition from current UK GAAP Arises due to restatement of prior periods’ taxable profits, which may be difficult to manage using gift aid. Basis of recognising deferred tax Recognised on the Recognised on the Recognised on the basis of ‘timing basis of timing basis of temporary difference plus’ differences. differences. approach. There are no significant differences between current UK GAAP and FRS 102 in the accounting for overseas transactions. However, there are some differences with regards to the accounting for overseas operations, which could affect those not-for-profit entities that operate abroad. Firstly, FRS 102 defines a foreign operation as ‘a subsidiary, joint venture or branch of a reporting entity, the activities of which are based or conducted in a country or currency other than those of the reporting entity.’ International charities, higher education institutions and other organisations operating overseas like professional bodies may need to consider whether their overseas activities should be accounted for as foreign operations. In terms of the accounting for foreign operations, two key differences have been identified: n When translating the income, expenditure and cash flows of foreign operations, current UK GAAP permits an average rate to be used. FRS 102, by contrast, only permits the use of an average rate where it approximates the exchange rates at the dates of the transactions entered into by the foreign operation. If exchange rates fluctuate significantly in an accounting period, then the use of a single average rate for the whole period is likely to be inappropriate n FRS 102 considers goodwill, other intangibles and fair value adjustments arising on consolidation to be assets of the foreign operation and therefore translated at the exchange rate ruling at the balance sheet date. Under current UK GAAP, most entities translate such items at historic rate (ie the rate ruling when the assets and liabilities of the operation were first brought into account). REVISIONS MADE TO PROPOSALS IN FRED 48 There are two main changes to the original proposals. Firstly, FRS 102 defines the term foreign operation, whereas FRED 48 did not. Secondly, FRED 48 required exchange gains and losses recognised as other comprehensive income (ie those arising on the retranslation of foreign operations) to be presented in the balance sheet as a separate reserve. This presentation requirement has not been carried forward into FRS 102. SUMMARY Issue FRS 102 Current UK GAAP and SORPs Retranslation of income, expenditure and cash flows of foreign operations Use of average Use of average rate permitted rate permitted. only to the extent it provides a reasonable approximation to the actual rate on the date of the transactions of the foreign operation EU endorsed IFRS Use of average rate permitted only to the extent it provides a reasonable approximation to the actual rate on the date of the transactions of the foreign operation. Translation of Translated at rates Usually translated Translated at rates goodwill, ruling at the at historic rate of ruling at the intangibles balance sheet date. exchange. balance sheet date. and other fair value adjustments arising on consolidation BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES 27 31. HYPERINFLATION It is anticipated this section will affect very few not-for-profit entities. The extent of any impact on transition to FRS 102 will depend largely on whether an entity has applied FRS 24 Financial reporting in hyperinflationary countries (a full IFRS-converged standard) or UITF Abstract 9 Accounting for operations in hyperinflationary economies. Where an entity has applied FRS 24 there will be relatively little impact. If the entity has applied UITF Abstract 9 then there could be differences, largely because it is less prescriptive than FRS 102 on how to eliminate the distortions caused by hyperinflation. 32. EVENTS AFTER THE END OF THE REPORTING PERIOD FRS 21 Events after the balance sheet date, which has been effective since 2005, is a full IFRS-converged standard. As the principles in FRS 102 are very similar to those contained in FRS 21, no significant areas of difference have been identified. n the Accounting Direction for Private Registered Providers of Social Housing 2012 requires disclosure of the full time equivalent number of staff whose remuneration payable in relation to the period of account fell within each band of £10,000 from £60,000 upwards. It also requires disclosure of the emoluments of the highest paid director (excluding pension contributions) and details of the chief executive's pension arrangements. FRS 102, however, requires disclosure of the aggregate amount of all forms of consideration paid and payable to key management personnel for services rendered. Key management personnel are defined as ‘those persons having authority and responsibility for planning, directing and controlling the activities of the entity, directly or indirectly’, and sometimes comprise a wider body than just the board of directors. Therefore not-for-profit entities will need to consider whether the need to disclose the remuneration of key management personnel imposes additional disclosure requirements over and above those required by the relevant regulatory body. SUMMARY REVISIONS TO PROPOSALS IN FRED 48 Issue FRS 102 FRS 102 contains additional guidance clarifying that an entity should not prepare its financial statements on a going concern basis if management determines after the reporting period that it intends to liquidate the entity or cease trading, or that it has no realistic alternative but to do so. Current UK GAAP and SORPs EU endorsed IFRS Identity of related party Name of related party does not need to be disclosed, only the nature of the relationship. Both the name of the related party and the nature of the relationship need to be disclosed. Name of related party does not need to be disclosed, only the nature of the relationship. Disclosure of transactions with group entities No requirement to disclose transactions between 100% owned entities of a group. No requirement to disclose transactions between 100% owned entities of a group. No exemption from disclosing transactions in an entity’s individual financial statements between itself and other entities within the same group. Disclosure of donations from related parties No exemption. Exemption given in charity SORP. No exemption. Remuneration of key management personnel Details of key management remuneration must be disclosed. Disclosures driven by relevant legislation and regulators. Not necessarily the case that these capture all members of ‘key management personnel’. Details of key management remuneration must be disclosed. 33. RELATED PARTY DISCLOSURES There are two key disclosure differences identified between FRS 102 and current UK GAAP (FRS 8 Related party disclosures). Firstly, FRS 8 requires both the names of related parties and the nature of their relationship to the reporting entity to be disclosed, whereas FRS 102 only requires disclosure of the nature of the related party relationship. Secondly, the charity SORP gives exemptions from disclosure of certain transactions, including most donations made by related parties. No such exemption is available under FRS 102. Note also that other legislation and regulation may impose additional related party disclosure requirements over and above those in FRS 102. For example, the Accounting Direction for Private Registered Providers of Social Housing 2012 sets out disclosure requirements in respect of transactions with non-regulated entities. KEY MANAGEMENT COMPENSATION FRS 8 excludes from its scope remuneration paid to employees. Disclosure of such information tends to be covered by other legislative or regulatory requirements, thus: n companies’ legislation sets out detailed requirements for remuneration of directors of companies (including charitable companies) n the charity SORP requires disclosure of remuneration and expenses received by trustees as well as the number of employees that receive remuneration in excess of £60,000 (in bands of £10,000) n the accounts directions issued by the HEFCE and the SFA require disclosure in the financial statements of HE&FE institutions of remuneration received by certain key members of staff and governors 28 BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES 34. SPECIALISED ACTIVITIES Section 34 deals with the accounting for a number of ad hoc topics. PUBLIC BENEFIT ENTITY ACCOUNTING The accounting for three topics that are available only to an entity meeting the definition of a PBE are dealt with in this section. It also deals with the accounting for another two topics (heritage assets and funding commitments) that are predominantly only going to be relevant to PBEs, but are nonetheless available to all entities. As these topics can be related directly to other sections of FRS 102 we have included a discussion of them above as follows: Concessionary loans See section 11 ‘Basic Financial Instruments’ Heritage assets See section 17 ‘Property, Plant and Equipment’ Public benefit entity combinations See section 19 ‘Business Combinations and Goodwill’ Funding commitments See section 21 ‘Provisions and Contingencies’ Income from non-exchange transactions See section 23 ‘Revenue’ EXTRACTIVE INDUSTRIES The accounting set out in FRS 102 for extractive industries (ie mining) is unlikely to be of relevance to not-for-profit entities. In summary, entities in the extractive industry must apply the full IFRS standard, namely IFRS 6 Exploration for and Evaluation of Mineral Resources. AGRICULTURE Due to their involvement in in agricultural activity or animal welfare, some charities and education institutions may need to consider the definition of agricultural activity to determine if they are within the scope of this section of FRS 102, particularly if any animals or agricultural produce are sold as part of the entities' activities. FRS 102 permits an accounting policy of either cost or fair value for each class of biological asset. REVISIONS MADE TO PROPOSALS IN FRED 48 FRED 48 did not provide an accounting policy choice, generally requiring all biological assets to be accounted for at fair value with changes in fair value recognised in the income statement. SERVICE CONCESSION ARRANGEMENTS A service concession arrangement is an arrangement where a public sector body or PBE, known as the grantor, contracts with a private sector entity, known as the operator, to construct (or upgrade), operate and maintain infrastructure assets for a specified period of time. Infrastructure assets are defined as 'infrastructure for public services such as roads, bridges, tunnels, prisons, hospitals, airports, water distribution facilities, energy supply and telecommunications networks'. Typically, service concession arrangements would encompass most PFI- and PPP-type contracts. Some not-for-profit entities, RPs and HEIs in particular, do enter into service concession arrangements, with FRS 102 providing guidance on the accounting by both the operator and the grantor. Under current UK GAAP, there is guidance on such contracts in FRS 5 Accounting for the substance of transactions. The key consideration under FRS 5 is whether an operator has assets (eg a property) used to provide the contracted services, or alternatively a debtor, being the right to receive payments for the contracted services (in which case the property is an asset of the grantor). Which of the two contracting parties should be recognising the asset and related liability is driven by an assessment of who is exposed to the associated risks and rewards of that asset. By contrast, FRS 102 only addresses the accounting for service concession arrangements where (i) the grantor controls or regulates what services the operator must provide, to whom, and at what price, and (ii) where the arrangement is for a period less than the useful economic life of the infrastructure assets, the grantor controls any significant residual interest in the property at the end of the term of the arrangement. Where these two conditions are met, the grantor rather than the operator will recognise the asset(s) which is (are) the subject of the contract, and a liability for the payments for its obligation under the service concession arrangement. HEIs may find themselves in this situation if, say, they enter into arrangements with other parties to refurbish, build, or take over student accommodation at some point in the future in return for payments or guaranteeing liabilities of the operator. Similarly, RPs could, as part of their key worker accommodation offering, enter into a contract with (say) an NHS hospital to provide accommodation to nurses, with the question arising as to whether the RP should recognise the properties or a debtor for rent and other amounts receivable (often called unitary charges) over the life of the contract. The precise considerations may be something that will be addressed in the revised HE&FE and housing SORPs. The operator follows one of two models depending on the nature of the contract. Under the first model it recognises a debtor representing its unconditional right to receive payment (often called a unitary charge) for having constructed the property, and also for its subsequent operation and maintenance. Judgement is likely to be needed in determining the revenue in relation to the construction of the property and the revenue for subsequent operation and maintenance. Under the second model, the operator does not have a right to receive fixed or determinable payments from the public body. Instead it is given a right to charge end users. Under this model, the entity recognises an intangible asset (the right to charge users) in exchange for having constructed the asset. This gives rise to revenue both on recognition of the intangible (with the construction costs being a cost of sale) and revenue when the public is charged for using the asset, with the associated costs comprising depreciation of the intangible asset. Therefore, over the life of the contract, total revenue exceeds total cash inflows and total costs exceeds total cash outflows, both augmented by an amount equal to the fair value ascribed to the intangible asset on initial recognition. REVISIONS MADE TO PROPOSALS IN FRED 48 The guidance on service concession arrangements has been extended to include the accounting by both grantors and operators. FRED 48 previously only addressed the accounting by operators. BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES 29 FINANCIAL INSTITUTIONS 35. TRANSITION TO FRS 102 Where an entity meets the definition of a financial institution, then it is required to give various additional disclosures concerning financial instruments. These disclosures may have relevance to certain not-forprofit entities that conduct financial services through subsidiaries. When an entity transitions from current UK GAAP, the basic rule is that the financial statements for both the current period and comparatives are presented in accordance with the requirements of the new regime. In order to present a comparative statement of comprehensive income and cash flow it is therefore necessary to have a balance sheet two years’ prior to the date of the first financial statements prepared under the new financial reporting framework (the transition date balance sheet). RETIREMENT BENEFIT PLANS The accounting for the cost of providing post-employment retirement benefits to its employees is covered by section 28 above. The guidance in section 34 deals with the accounting to be applied in the financial statements of retirement benefit plans. SUMMARY Issue FRS 102 Current UK GAAP and SORPs EU endorsed IFRS Biological assets Choice of cost or fair value for each class of biological asset. Measured at cost. Measured at fair value. Types of PFI/PPP contracts covered Contracts that do not result in recognition of property assets by the operator. All types. Contracts that do not result in recognition of property assets by the operator. Focus of PFI/PPP accounting Assessment by reference to control to determine if assets and liabilities should be recognised. Asset to be recognised may be debtor or intangible asset. Assessment of risks and rewards to determine if assets and liabilities should be recognised. Asset to be recognised may be debtor or tangible fixed asset. Assessment by reference to control to determine if assets and liabilities should be recognised. Asset to be recognised may be debtor or intangible asset. Recognising that the costs of requiring entities to prepare opening balance sheets on the basis that the entity had always complied with the new framework would exceed the likely benefits, certain exemptions are given from full retrospective application in preparation of the transition balance sheet. The key reliefs are: n business combinations effected before the date of transition do not need to be restated to comply with the requirements of Section 19 above n certain assets (such as property, plant and equipment) can be measured at fair value on the date of transition and used as deemed cost. Additionally, a previous UK GAAP valuation of certain assets at the date of transition can be used as deemed cost. This simplifies matters for entities that have previously revalued such assets but wish to adopt a policy of cost going forward n the accounting for service concession arrangements only has to be applied to contracts entered into after the date of transition, with current UK GAAP able to be applied to such contracts entered into pre-transition n deferred tax need not be recognised as at the date of transition if it would involve ‘undue cost or effort’ n dormant entities need not restate any balances n entities that previously did not capitalise borrowing costs may adopt a policy of capitalisation on transition to FRS 102 without restating the transition date balance sheet as if such a policy had always been applied n Assessment of whether an arrangement contains a lease (Section 20) may be made based on facts and circumstances at the date of transition rather than the contract date. In addition, there are situations where entities are not permitted to restate the transition date balance sheet. In the context of PBEs, the key situations are: n accounting estimates made under current UK GAAP are revised only prospectively n hedge accounting applied under current UK GAAP is reflected in the transition date balance sheet with the subsequent accounting considering the rules in FRS 102 on financial instruments (ie whether or not hedge accounting should be discontinued). The following disclosures are required in the first financial statements prepared in compliance with FRS 102: n a description of the nature of each change in accounting policy n a reconciliation of net assets determined in accordance with current UK GAAP and FRS 102 for both the date of transition and the comparative period n a reconciliation of the income statement determined in accordance with current UK GAAP and FRS 102 for the comparative period. Appendices 1, 2 and 3 give an example of the way these disclosures may be presented in an entity's first financial statements prepared under FRS 102. 30 BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES APPENDIX 1 RECONCILIATION OF HYPOTHETICAL CHARITY SOFA TO STATEMENT OF COMPREHENSIVE INCOME As reported As reported under Adjustment Adjustment Adjustment Adjustment Adjustment Adjustment Adjustment Adjustment Adjustment under UK GAAP FRS 102 1 2 3 4 5 6 7 8 9 £’000 £’000 £’000 £’000 £’000 £’000 £’000 £’000 £’000 £’000 £’000 INCOMING RESOURCES Incoming resources from generated funds 50,000 Incoming resources from charitable activities 2,500 2,500 Other incoming resources 3,000 3,000 Total incoming resource (2,500) 55,500 0 0 Costs of generating funds 20,000 (100) 2,000 Charitable activities 10,000 (2,500) 1,000 0 1,000 10,000 0 0 0 58,500 10,000 64,000 10,000 32,250 RESOURCES EXPENDED Governance costs 2,000 (Gains)/losses on investment assets 0 Interest expense 0 Other resources expended 3,000 200 150 500 9,500 2,000 2,500 2,500 100 100 3,000 Total resources expended 35,000 (100) 2,000 0 200 500 150 100 2,500 10,000 50,350 Net income for the period 20,500 100 (2,000) (2,500) (200) 500 (150) (100) (2,500) 0 13,650 GROSS TRANSFERS BETWEEN FUNDS 0 OTHER COMPREHENSIVE INCOME Gains on revaluation of fixed assets for charity's own use Gains/(losses) on investment assets 5,000 1,000 6,000 (2,500) Actuarial gains/(losses) on defined benefit pension schemes Total comprehensive income for the period 2,500 (350) 22,650 100 1,100 (2,000) (2,500) (200) 500 (150) 0 (250) 0 0 19,400 RECONCILIATION OF FUNDS Total funds brought forward 100,000 Total funds carried forward 122,650 Adjustment 1 Adjustment 2 Adjustment 3 Adjustment 4 Adjustment 5 Adjustment 6 Adjustment 7 Adjustment 8 Adjustment 9 Net change on gains and depreciation in period arising from use of fair value not existing use value as valuation basis of owner occupied properties Net movement in period on agreed funding of multi-employer scheme deficit Net movement in period arising from earlier recognition of legacy income (subject to any specific guidance contained in revised charity SORP) Net movement in period on staff holiday accrual Net movement in period on donated goods held for distribution Net movement in period on lease incentive accrual Net effect in period of revised method for determining interest cost on defined benefit pension scheme accounting Net change in fair value of equity investments and investment properties recognised in the income statement Effect of an entity arguing it can reliably measure value of volunteer time (subject to any specific guidance contained in charity SORP) Other adjustments may include, but are not restricted to: financial instruments, investment property, recognition of intangibles on certain combinations with other entities, accounting for arrangements that contain a lease, grant income (subject to the revised SORP permitting the use of the accruals model), deferred tax, re-assessment of foreign operations, and adjustments arising from any agricultural activity. BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES 31 RECONCILIATION OF HYPOTHETICAL CHARITY BALANCE SHEET TO STATEMENT OF FINANCIAL POSITION As reported under UK GAAP £’000 Adjustment 1 £’000 100,000 5,000 Adjustment 2 £’000 Adjustment 3 £’000 Adjustment 4 £’000 Adjustment 5 £’000 Adjustment 6 £’000 Adjustment 7 £’000 As reported under FRS 102 £’000 (10,000) 95,000 LONG-TERM ASSETS Tangible assets Investment property 10,000 10,000 Investments 25,000 25,000 135,000 130,000 CURRENT ASSETS Debtors due after more than one year Debtors due in less than one year 25 2,000 9,500 11,525 2,500 2,000 500 5,000 Stocks and WIP [Inventory] 750 Investments 500 500 7,500 7,500 Cash at bank and in hand 3,500 4,250 11,275 CREDITORS: AMOUNTS FALLING DUE WITHIN ONE YEAR NET CURRENT ASSETS TOTAL ASSETS LESS CURRENT LIABILITIES CREDITORS: AMOUNTS FALLING DUE AFTER MORE THAN ONE YEAR 28,775 (10,000) (2,000) (1,000) (2,500) (15,500) 1,275 13,275 136,275 143,275 (30,000) (8,000) (5,500) (43,500) PROVISIONS FOR LIABILITIES (3,250) (6,525) DEFINED BENEFIT PENSION LIABILITY (6,525) 6,525 TOTAL ASSETS LESS TOTAL LIABILITIES 96,500 5,000 (10,000) 4,000 (6,500) 3,500 (6,500) 3,000 (2,500) 0 (9,775) 90,000 FUNDS Endowment Funds 10,000 (5,000) Restricted income funds 16,500 (5,000) 5,000 8,000 Unrestricted income funds Net accumulated surplus 56,525 Revaluation reserve 20,000 Pension reserve (6,525) 96,500 Adjustment 1 Adjustment 2 Adjustment 3 Adjustment 4 Adjustment 5 Adjustment 6 Adjustment 7 4,000 500 (2,500) (6,525) 5,000 52,000 25,000 6,525 5,000 (10,000) 4,000 (6,500) 3,500 (2,500) 0 90,000 Change arising from use of fair value not existing use value as valuation basis of owner occupied properties Recognition of liability for agreed funding of multi-employer scheme deficit Effect of earlier recognition of legacy income (subject to any specific guidance contained in revised charity SORP) Recognition of staff holiday accrual Adjustment to basis of recognition of goods donated for distribution Adjustment to basis of recognition of lease incentives Presenting lease premiums as a prepayment of rent and transfer of defined benefit pension liability to provisions Other adjustments may include, but are not restricted to: financial instruments, investment property, recognition of intangibles on certain combinations with other entities, accounting for arrangements that contain a lease, grant income (subject to the revised SORP permitting the use of the accruals model), deferred tax, re-assessment of foreign operations, and adjustments arising from any agricultural activity. 32 BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES APPENDIX 2 RECONCILIATION OF HYPOTHETICAL REGISTERED PROVIDER OF SOCIAL HOUSING INCOME STATEMENT Turnover As reported under UK GAAP £’000 Adjustment 1 £’000 30,000 (500) Cost of sales (8,000) Operating costs (17,500) Other operating income 0 Operating surplus 4,500 Share of post-tax profit of JCEs 100 Interest receivable and other income 2,000 Other finance costs (100) (2,750) Adjustment 7 £’000 Adjustment 8 £’000 Adjustment 9 £’000 As reported under FRS 102 £’000 29,500 (1,500) (1,500) (500) 0 200 2,000 600 1,500 600 (25) (18,925) 30 200 5 0 100 2,730 100 5,305 30 60 2,300 (450) (100) (50) (3,240) 50 Tax on surplus on ordinary activities (800) 10 Surplus for the year 3,000 0 Adjustment 8 Adjustment 9 Adjustment 6 £’000 300 (10) Adjustment 6 Adjustment 7 Adjustment 5 £’000 (100) 3,800 Adjustment 5 Adjustment 4 £’000 (8,000) 400 Surplus on ordinary activities before taxation Adjustment 1 Adjustment 2 Adjustment 3 Adjustment 4 Adjustment 3 £’000 30 Surplus on disposal of housing properties Interest payable and similar charges Adjustment 2 £’000 (1,500) (150) 1,500 600 200 5 (50) 0 4,395 (790) (1,500) (150) 1,500 600 200 5 (50) 0 Effect of applying equity accounting to JANEs on basis they meet the definition of JCEs Recognition of PFI arrangement - amortisation of intangible received in exchange for construction of asset Net change in fair value of interest rate swap (assuming hedge accounting not applied or not available) and index-linked bonds Net effect of reclassifying certain properties and tenures as investment properties on the basis they are held primarily for rental income or capital gain Net effect in period of revised allocation of grant following re-classification of certain properties as investment properties (subject to further clarification in revised housing SORP) Net movement in period on agreed funding of multi-employer scheme deficit Net effect in period of presenting properties gross of grant income, release of non-governmental grants subject only to restrictions and knock-on impairment charges (subject to further clarification in revised housing SORP) Net effect in period of revised method for determining interest cost on defined benefit pension scheme accounting Reclassification of post-operating surplus exceptional item Other adjustments may include, but are not restricted to: accounting for derivatives where hedge accounting is applied, recognition of intangibles on certain combinations with other RPs, accounting for lease incentives, accounting for arrangements that contain a lease, numerous adjustments relating to SHG (subject to any guidance included in revised SORP), accounting for stock transfers and attached SHG (subject to any guidance included in revised SORP), basis and timing of measuring impairment losses (subject to any guidance included in revised SORP), holiday pay and deferred tax. 3,605 BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES 33 RECONCILIATION OF HYPOTHETICAL REGISTERED PROVIDER OF SOCIAL HOUSING BALANCE SHEET TO STATEMENT OF FINANCIAL POSITION As reported under UK GAAP £’000 Adjustment 1 £’000 Housing properties 200,000 (20,000) Social housing grant (100,000) Adjustment 2 £’000 Adjustment 3 £’000 Adjustment 4 £’000 Adjustment 5 £’000 Adjustment 6 £’000 Adjustment 7 £’000 Adjustment 8 £’000 As reported under FRS 102 £’000 FIXED ASSETS Intangible asset 2,000 Other grants 2,000 (20,000) (10,000) 5,000 150,000 95,000 (20,000) 20,000 Investment properties 40,000 40,000 Other items of property, plant and equipment 6,000 6,000 Investments - homebuy loans advanced 10,000 10,000 Grants received related to homebuying loans (7,000) Investment in JCE 7,000 20,600 20,600 228,600 89,000 CURRENT ASSETS Properties for sale Debtors Cash at bank and in hand CREDITORS: AMOUNTS FALLING DUE WITHIN ONE YEAR 10,000 (1,000) 4,000 (400) (2,200) 6,800 3,600 2,000 16,000 (200) 1,800 12,200 (12,000) 300 (250) (200) (1,000) (13,150) NET CURRENT ASSETS 4,000 (950) TOTAL ASSETS LESS CURRENT LIABILITIES 93,000 227,650 CREDITORS: AMOUNTS FALLING DUE AFTER MORE THAN ONE YEAR (70,000) 700 (4,750) (1,800) (96,000) (171,850) PROVISIONS FOR LIABILITIES (2,000) (3,000) DEFINED BENEFIT PENSION LIABILITY (3,000) 3,000 Total net assets 18,000 RESERVES Share capital Designated reserve Revenue reserve Adjustment 6 Adjustment 7 Adjustment 8 (200) (5,000) 20,000 5,000 (2,000) 15,000 0 50,800 0 0 2,750 2,750 15,250 18,000 Adjustment 1 Adjustment 2 Adjustment 3 Adjustment 4 Adjustment 5 0 (5,000) 0 (200) (5,000) 20,000 5,000 (2,000) 15,000 (200) (5,000) 20,000 5,000 (2,000) 15,000 48,050 0 50,800 JANE accounting re-presented as JCE accounting Recognition of PFI arrangement - intangible received in exchange for construction of asset Recognition of interest rate swaps and index-linked debt at fair value Recognition of certain properties and tenures as investment properties on the basis they are held primarily for rental income or capital gain Effect of re-allocating grant following re-classification of certain properties as investment properties (subject to further clarification in revised housing SORP) Recognition of liability for agreed funding of multi-employer scheme deficit Effect of presenting properties gross of grant income, release of non-governmental grants subject only to restrictions and knock-on impairment charges (subject to further clarification in revised housing SORP) Transfer of defined benefit pension liability to provisions Other adjustments may include, but are not restricted to: accounting for derivatives where hedge accounting is applied, recognition of intangibles on certain combinations with other RPs, accounting for lease incentives, accounting for arrangements that contain a lease, numerous adjustments relating to SHG (subject to any guidance included in revised SORP), accounting for stock transfers and attached SHG (subject to any guidance included in revised SORP), basis and timing of measuring impairment losses (subject to any guidance included in revised SORP), holiday pay and deferred tax. 34 BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES APPENDIX 3 RECONCILIATION OF HYPOTHETICAL HIGHER EDUCATION INSTITUTION INCOME STATEMENT As reported As reported under Adjustment Adjustment Adjustment Adjustment Adjustment Adjustment Adjustment Adjustment Adjustment under UK GAAP FRS 102 1 2 3 4 5 6 7 8 9 £’000 £’000 £’000 £’000 £’000 £’000 £’000 £’000 £’000 £’000 £’000 Income Funding body grants 60,000 Tuition fees and education contracts (inc share of JV) 36,000 Research grants and contracts 30,000 Other income 40,000 5,000 65,000 (2,100) 33,900 30,000 900 40,900 Profit on disposal of property Endowment and investment income Total income (inc share of JV) Less share of joint venture income Net income 3,000 169,000 0 0 900 (500) (2,500) 4,500 (2,500) (2,100) 750 750 750 170,550 0 (2,100) 0 2,100 166,900 Expenditure Staff costs 90,000 Other operating expenses 60,000 (500) Depreciation and amortisation 10,000 100 150 1,000 91,150 59,500 (200) 9,900 Fundamental restructuring costs Interest and other finance costs Total expenditure Income less expenditure Share of profit of JCE 3,000 2,500 (50) 3,000 2,450 162,500 150 (400) (200) 1,000 0 0 0 (50) 3,000 166,000 4,400 (150) 400 1,100 (1,000) 4,500 (2,500) 0 50 (2,250) 4,550 400 400 Share of loss in associate (100) Taxation (200) Surplus after tax 4,500 (150) Surplus attributable to non-controlling interest (100) (10) Surplus for the year before exceptional items 4,400 100 0 (200) 400 1,100 (1,000) 4,500 (2,500) 100 50 (2,250) 4,750 Surplus attributable to the parent Disposal of fixed assets Fundamental restructuring costs 750 (750) (3,000) 3,000 Surplus on continuing operations after depreciation of assets at valuation, disposal of assets and tax 2,150 (Deficit) / surplus transferred to accumulated income in endowment funds (100) Surplus for the year retained within general reserves 2,050 Adjustment 1 Adjustment 2 Adjustment 3 Adjustment 4 Adjustment 5 Adjustment 6 Adjustment 7 Adjustment 8 Adjustment 9 (110) 4,640 Net movement in period on staff holiday accrual Net effect in period of adopting a policy of capitalising libraries and associated depreciation Net gain in period on investment property element of mixed-use property, and removal of associated depreciation Net movement in period on agreed funding of multi-employer scheme deficit Net movement in period arising from deferral of income from non-exchange transactions subject to performance conditions and release of deferred income subject only to restrictions Net fair value gains in period on fixed and current asset equity investments Adjustment in period to restrict share of associates' losses recognised and cessation of gross equity method for JCEs Net effect in period of revised method for determining interest cost on defined benefit pension scheme accounting Reclassification of exceptional items as operating expenses Other adjustments may include, but are not restricted to: accounting for financial instruments such as derivatives, recognition of intangibles on certain combinations with other HEIs, deferred tax, recognition in I&E of government grant (subject to revised SORP permitting continued use of the accrual method), JV accounting, accounting for lease incentives, accounting for arrangements that contain a lease, recognition of legacy income (subject to any specific guidance included in the revised SORP), deferred tax, foreign operations, agricultural activity, and service concession arrangements (depending on whether the entity chooses to adopt transitional arrangements). BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES 35 RECONCILIATION OF HYPOTHETICAL HIGHER EDUCATION INSTITUTION BALANCE SHEET TO STATEMENT OF FINANCIAL POSITION As reported As reported under Adjustment Adjustment Adjustment Adjustment Adjustment Adjustment Adjustment Adjustment under UK GAAP FRS 102 1 2 3 4 5 6 7 8 £’000 £’000 £’000 £’000 £’000 £’000 £’000 £’000 £’000 £’000 LONG-TERM ASSETS Intangible assets 1,000 Tangible Assets 1,000 110,000 7,500 Investment property (6,000) 111,500 8,000 Investments 8,000 2,000 1,000 Investments in joint venture Share of gross assets 1,000 4,000 500 500 1,750 (1,750) Share of gross liabilities (1,250) 113,500 1,250 ENDOWMENT ASSETS 1,500 (1,500) 125,000 CURRENT ASSETS Debtors 13,250 Investments 25,000 Cash at bank and in hand 10,000 49,750 CREDITORS: AMOUNTS FALLING DUE WITHIN ONE YEAR NET CURRENT LIABILITIES TOTAL ASSETS LESS CURRENT LIABILITIES CREDITORS: AMOUNTS FALLING DUE AFTER MORE THAN ONE YEAR PROVISIONS FOR LIABILITIES (50,000) 13,250 3,500 500 (2,000) (1,000) 10,500 52,250 (53,000) (250) (750) 113,250 124,250 (30,000) (9,000) (39,000) (3,250) 500 ACCRUALS AND DEFERRED INCOME DEFINED BENEFIT PENSION SCHEME LIABILITY 28,500 (20,000) (22,750) (5,000) (5,000) (20,000) TOTAL NET ASSETS 60,000 DEFERRED CAPITAL GRANTS 30,000 20,000 (2,000) 7,500 2,000 (10,000) (5,000) 4,500 500 0 57,500 (30,000) ENDOWMENTS Expendable 1,000 (750) 250 Permanent 500 (250) 250 RESERVES Income and expenditure account Pension reserve Minority interests TOTAL FUNDS Adjustment 1 Adjustment 2 Adjustment 3 Adjustment 4 Adjustment 5 Adjustment 6 Adjustment 7 Adjustment 8 47,500 (1,950) 7,500 2,000 (10,000) 26,000 4,500 500 (20,000) (20,000) 56,050 20,000 1,000 (50) 60,000 (2,000) 950 7,500 2,000 (10,000) (5,000) 4,500 500 0 57,500 Recognition of staff holiday accrual Recognition of library stocks as a long-term asset Investment property element of mixed-use property measured at fair value Recognition of liability for agreed funding of multi-employer scheme deficit Deferral of income from non-exchange transactions subject to performance conditions and release of deferred income subject only to restrictions Effect of measuring equity investments at fair value Elimination of share of net liabilities of associate Transfer of defined benefit pension liability to provisions, endowments to underlying asset class, and cessation of gross equity method for JCEs Other adjustments may include, but are not restricted to: accounting for financial instruments such as derivatives, recognition of intangibles on certain combinations with other HEIs, deferred tax, recognition in I&E of government grant (subject to revised SORP permitting continued use of the accrual method), JV accounting, accounting for lease incentives, accounting for arrangements that contain a lease, recognition of legacy income (subject to any specific guidance included in the revised SORP), deferred tax, foreign operations, agricultural activity, and service concession arrangements (depending on whether the entity chooses to adopt transitional arrangements). 36 BDO / GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND NOT-FOR-PROFIT ENTITIES OUR NOT-FOR-PROFIT SEMINARS SEMINARS HELD AT: 55 Baker Street, London, W1U 7EU. Please arrive 15 minutes before the start time to register. Breakfast is provided prior to the morning seminars. Pre-booking essential TO REGISTER THURSDAY 10 OCTOBER HEI Audit Committee Seminar Breakfast seminar 8.00am – 9.30am An overview of members’ responsibilities and update on key sector issues. WEDNESDAY 13 NOVEMBER Social housing tax update Breakfast seminar 8.30am – 10.00am There are three simple ways to reserve your place at these events: Call Jane West on 01293 591 000 Email jane.west@bdo.co.uk Visit www.bdo.co.uk/events Our annual update for registered providers of social housing covering latest developments in corporation tax, VAT and employment taxes. THURSDAY 28 MARCH Public Benefit Accounting Group 9.30am – 1.00pm (lunch included) SEMINARS HELD AT: BIRMINGHAM This meeting provides an opportunity to discuss the impact of the new Financial Reporting Standard (FRS 102) on Not-for-Profit organisations THURSDAY 28 MARCH Charity Finance Update Afternoon seminar 4.00pm – 6.00pm Our six monthly update on finance developments in the charity sector covering reporting, tax and governance issues. TUESDAY 14 MAY VAT and PAYE review Breakfast seminar 8.30am – 10.00am A detailed look at changes and new developments with VAT and PAYE. Relevant to all Not-for-Profit organisations. TUESDAY 25 JUNE FE Audit Committee Seminar Breakfast Seminar 8.00am – 9.30am An overview of members’ responsibilities and update on key sector issues. TUESDAY 2 JULY HEI Audit Committee Seminar Breakfast seminar 8.00am – 9.30am An overview of members’ responsibilities and update on key sector issues. WEDNESDAY 18 SEPTEMBER Charity Finance Update Breakfast seminar 8.30am – 10.00am Our six monthly update on finance developments in the charity sector covering reporting, tax and governance issues. TUESDAY 24 SEPTEMBER FE Audit Committee Seminar Breakfast Seminar 8.00am – 9.30am An overview of members’ responsibilities and update on key sector issues. BDO, 125 Colmore Row, Birmingham B3 3SD Please arrive 15 minutes before the start time to register. Breakfast is provided prior to the morning seminars. Pre-booking essential TO REGISTER There are three simple ways to reserve your place at these events: Call Jane West on 01293 591 000 Email jane.west@bdo.co.uk Visit www.bdo.co.uk/events TUESDAY 26 MARCH WEDNESDAY 25 SEPTEMBER Charity Finance updates Afternoon seminars 4.00pm – 6.00pm Our six monthly update on finance developments in the charity sector covering reporting, tax and governance issues. TUESDAY 16 APRIL TUESDAY 1 OCTOBER Afternoon seminars 4.00pm – 6.00pm Social Housing Audit Committee seminars An overview of members’ responsibilities and update on key sector issues. TUESDAY 11 JULY Trustee Training Afternoon seminar 4.00pm – 6.00pm Our annual update tailored for trustees looking at best practice and recent developments in governance. WEDNESDAY 13 NOVEMBER Fraud and Controls seminar Afternoon seminar 4.00pm – 6.00pm It is always necessary to maintain the key controls within your organisation in order to minimise the risk of fraud. In this seminar we will provide attendees with the opportunity to hear our views on controls and share case studies where it all goes wrong. ABOUT BDO BDO provides a comprehensive range of business advice and accounting services throughout the UK and world-wide. BDO is an award-winning UK Member Firm of BDO International, the world’s fifth largest accountancy network, with more than 1,000 offices in over 100 countries. Encompassing charities, education, social housing and membership organisations, our not-for-profit organisations group combines detailed sector knowledge with the global reach of the BDO International network. If you would like more information on our services, please contact your local BDO contact or one of the partners listed below: DON BAWTREE, Partner, Head of Not-for-profit don.bawtree@bdo.co.uk ANDREW STICKLAND, Partner, Charities andrew.stickland@bdo.co.uk JAMES ASTON MBE, Partner, Education james.aston@bdo.co.uk PHILIP REGO, Partner, Social Housing philip.rego@bdo.co.uk ANDREW MCNAMARA, Partner, Scotland Not-for-profit andrew.mcnamara@bdo.co.uk www.bdo.co.uk This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO LLP to discuss these matters in the context of your particular circumstances. BDO LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it. BDO LLP, a UK limited liability partnership registered in England and Wales under number OC305127, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. A list of members’ names is open to inspection at our registered office, 55 Baker Street, London W1U 7EU. 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