FRS 102: Tell us a story

The principles that
govern the preparation of accounts are changing, with significant implications for law firms that could affect profit figures.

For the majority of those
not already required to report under International Financial Reporting Standards (IFRS), Financial Reporting Standard (FRS) 102 will replace the generally accepted accounting principles (GAAP).

The publishing body, the Financial Reporting Council (FRC), wanted a simplified accounting regime that was more up to date and relevant.

With the document coming
in at less than 300 pages long
(in comparison to the 3,000 pages of the UK GAAP), they appear to have achieved their objective. However, this does constitute a change to accounting requirements and will require sensible planning
to ensure a smooth transition.

FRS 102 is a single set of accounting and disclosure requirements developed by the FRC as a hybrid of IFRS and the existing UK GAAP. It is designed to be principles based, with fewer prescribed requirements.

The FRC wants to encourage preparers of accounts to use them to tell the story of performance and financial position.

FRS 102 will apply to all UK
and Irish entities, except for those applying IFRS or the Financial Reporting Standard
for Smaller Entities (FRSSE).
It is applicable to companies
and limited liability partnerships.

FRS 102 will need to be applied to accounts for most firms with accounting periods beginning on or after 1 January 2015. If your firm is of a size that means you can use the FRSSE (meeting any two of the limits:
a turnover of less than £6.5m, total assets of less than £3.26m, or less than 50 employees), then you have a year longer to adopt
FRS 102. It will then apply to accounting periods beginning on or after 1 January 2016.

The transition will
require comparative financial information to be prepared,
so consideration also needs
to be given to how the new standard applies to results
for previous periods.

Significant impact

FRS 102 is a significant change and can directly affect profit figures. This means that firms
will need to consider its impact on profit-sharing agreements, banking covenants, tax liabilities, and the level of reserves available for dividend distribution.

Below are the key changes that might impact solicitor practices:

• Goodwill: Where the goodwill of a practice is recognised on its balance sheet, FRS 102 requires goodwill to be amortised (written off in the profit and loss account) over its useful economic life. There is no concept of an indefinite useful life: the assumed limit for a useful life is ten years unless a longer period can be reliably measured and justified;
• Loan carrying no interest or interest below market rate: Where loans are provided to the practice (including directors’ loan account balances) carrying no interest or interest below market rate, there will no longer be the option of not recognising market rate interest. Instead, the loan will be recognised on the balance sheet by discounting the expected cash flows using a market rate of interest, which means that an annual interest charge is recognised in the profit and loss account;
• Holiday pay: Where there is a material liability to pay for unutilised holiday entitlement of employees at the firm’s year end, FRS 102 explicitly includes a requirement to provide for this liability in the accounts as a creditor; and
• Leases: Under the current UK GAAP, the value of rent-free periods and other lease incentives is spread over the period leading to the first rent review. Under FRS 102 lease incentives are spread over the entire lease term. FRS 102 requires the disclosure of the total future minimum lease commitment instead of the current UK GAAP requirement to disclose only the annual commitment.

There are many more implications for a firm’s financial statements that could arise
as a result of FRS 102. A wise
move would be to take this opportunity to discuss what is needed for your firm to adopt the new regime and interpret the new rules it involves. SJ

Jennifer Williamson is a business consultant partner at Kreston Reeves

@KrestonReeves