What next for FRS 102?

Two of the most significant changes proposed in FRED 82, the FRC’s second periodic review of FRS 102, concern leasing and revenue. Mike O’Halloran delves into the details

Financial Reporting Standard 102 (FRS 102) landed on the scene over 10 years ago to much fanfare. 

Its introduction was a sizeable task which involved replacing all previously extant Financial Reporting Standards, Statements of Standard Accounting Practice and Urgent Issues Task Force Abstracts in Ireland and the UK, with the single financial reporting standard we now know as FRS 102. 

In tandem, a reduced disclosure framework and framework for micro entities were born.
The replacement of the previously extant mismatch of accounting standards with a single framework was a seismic task, but a necessary one. 

It enabled users of financial statements to receive high-quality and understandable financial information, which had a consistency with International Financial Reporting Standards (IFRS), whilst being proportionate and cost-effective for entities to apply.

Periodic review

One of the cornerstones of FRS 102, and other standards maintained by the Financial Reporting Council (FRC), such as FRS 105, is that they are subject to periodic review at least every five years.

Periodic reviews allow the FRC to consider what is and isn’t working in the current standard, whether there are any emerging issues that need to be addressed, and whether there are any changes at International Accounting Standard (IAS) level that should be considered for inclusion. 

In December 2022, the FRC released Financial Reporting Exposure Draft 82 (FRED 82). FRED 82 sets out the FRC’s proposed changes as part of the second periodic review of the standard, including incremental improvements and clarifications. This article focuses on two key changes proposed in FRED 82 to Leasing and Revenue.

FRED 82 and leasing

Arguably the most significant change proposed in the periodic review is to lease accounting. The FRC has proposed, in FRS 102 only, a lease accounting regime consistent with IFRS 16 - Leases, which was introduced at International Accounting Standards (IAS) level in 2019. 

So, why is a change to the way in which entities account for leases deemed necessary by the FRC? 

It is a widely held view that “on-balance sheet” accounting for lessees provides a more faithful representation of leasing transactions and therefore provides more useful information to users of financial statements. 

The current requirements for lessees—whereby entities first must distinguish whether a lease is “operating” or “financing”—can result in leases, which are quite similar being accounted for very differently. 

This is especially relevant where there is a significant level of judgement used in determining the lease classification. 

In addition to this, leases currently classified as operating leases are accounted for in a manner that understates the lessee’s level of indebtedness on the balance sheet, as well as the value of assets an entity has the right to use. 

The change is also intended to improve comparability for users of financial statements. This includes comparability between entities that apply IFRS to those that apply FRS 102.

However, it also includes comparability between entities that apply FRS 102 while also acquiring assets in different ways—an entity that obtains a bank loan to buy an asset, for example, or leases an asset for a set number of years.

Opponents of the change may argue that the proposed leasing changes are not appropriate for smaller entities—or that the increase in assets caused by bringing right-of-use assets into fixed assets may cause a change in the size of some companies, which could have other implications (such as a loss of audit exemption).

IFRS 16 has now been in operation at IAS level since 2019 and, after a number of years of implementation, would appear to be operating well. 

The FRC has indicated that, based on its communications from stakeholders to date, there is strong support for the accounting rules of IFRS 16 to be introduced into FRS 102, provided that the standard offers simplifications in certain areas to make it appropriate and cost-effective for SMEs to apply.

The FRC has responded by including some simplifications within FRED 82. These include:

• The use of discount rates which should be easier to determine;
• A reduction in the number of situations in which lease modifications will require a new discount rate;
• The option to apply IFRS 16 in full (which may benefit entities who report up to a parent preparing in IFRS);
• The retention of the short lease exemption and low value exemption, with guidance in the standard on how to apply these; and
• A simplified transition method, using the modified retrospective approach.
  While big changes are proposed for entities with leases under FRS 102, the FRC has decided not to incorporate these changes into FRS 105. It has noted that there was significant concern that the requirements would be too complicated for micro-entities, and that the costs of implementing the changes would exceed the benefits.

FRED 82 and Revenue

The periodic review proposes that the current Section 23 - Revenue be rewritten entirely and replaced with a single comprehensive framework based on five steps of revenue recognition. 

In addition, it is proposed that the appendix to Section 23 be removed. These measures are intended to align the revenue recognition requirements in FRS 102 and FRS 105 with those of IFRS 15-Revenue from Contracts with Customers (IFRS 15), which has been in effect at IAS level since 2018.

In explaining its rationale for proposing this change, the FRC highlighted in its basis for conclusion in FRED 82, that the changes made to IFRS 15 were “developed to provide a single comprehensive framework for revenue recognition and to remove certain inconsistencies and weaknesses in the previous revenue standards that IFRS 15 replaced”. 

The FRC also highlighted the fact that IFRS 15 accounting provided more useful information to users of financial statements. The feedback it received from stakeholders was generally supportive of the introduction of such a model, provided this would be done in a proportionate manner, with appropriate simplifications to ensure the requirements are cost-effective to apply.

The proposed amendments will ensure that revenue recognition is focused largely on a five-step model. This means that an entity must apply the following five steps when determining how to account for its revenue:

• Identify the contract(s) with a customer;
• Identify the promises in the contract;
• Determine the transaction price;
• Allocate the transaction price to the promises in the contract; and
• Recognise revenue when (or as) the entity satisfies a promise.

Impact of proposed changes

Many entities may assume (and some may correctly assume) that the proposed changes will not have a significant impact on how they currently measure and recognise their revenue. 

However, this would be an inappropriate assumption to make. 

Entities will have to consider the nature of the contracts they have in place with their customers in line with the five-step model, in order to establish the appropriate accounting treatment.

Unlike leasing, it is intended that the proposed changes to revenue be incorporated into FRS 105, making it the most significant change to that standard. 

This is to ensure that a consistent revenue accounting framework applies across the board. However, the changes have been adapted to reflect the legal requirements, size and nature of micro-entities.

Some additional notable changes

This article does not cover all of the proposed changes detailed in FRED 82, but some other proposed changes include:

• A redrafted Section 2 – Concepts and Pervasive Principles in FRS 102 and FRS 105 to ensure consistency with the IASB’s Conceptual Framework for Financial Reporting;
• Enhanced going concern disclosures whereby an entity applying FRS 102 must state that it has applied the going concern basis, as well as confirmation that it has considered information about the future in applying the going concern basis;
• For UK companies only, disclosures which are currently contained in Appendix E of Section 1A (encouraged disclosures) are proposed to be moved to Appendix C (mandatory disclosures);
• A new Section 2A - Fair Value Measurement, to replace the Appendix to Section 2, reflecting the principles of IFRS 13;
• A focus, in Section 8 – Notes to the Financial Statements on disclosing “material accounting policy information” rather than “significant accounting policies”. This includes more guidance on when accounting policy information is material;
• An introduction of the definition of an “Accounting Estimate”; and
• A removal of the option to newly adopt the measurement and recognition requirements in IAS 39 as currently allowed by Sections 11 and 12 (with a view to its ultimate removal entirely).

IFRS for SMEs periodic review

It is worth noting that the FRC’s periodic review is ongoing at a time when the International Accounting Standards Board (IASB) is carrying out a similar periodic review of its SME standard—the IFRS for SMEs. 

FRS 102 was developed from the IFRS for SMEs and, therefore, a change at this level prompts the FRC to strongly consider whether a similar change is required at FRS 102 level. 

There are some notable differences between the approach taken by the FRC and IASB. 
The IASB has decided not to introduce IFRS 16 leasing rules to its standard, for example, whereas the FRC has (outlined above). 

Also, the IASB has decided to align its standard with the expected credit loss model of IFRS whereas the FRC has decided against this, instead deferring its decision on this to a later date.

What’s next?

FRS 102 covers a lot of ground when it comes to the type, size and complexity of the entities that use it. Users vary from small entities to large—from credit unions to charities and from pharmacies to Premier League Football clubs. 

It is a standard that must cover a lot of bases in order to meet the needs of the users of its financial statements. 

The FRC highlighted, during its recent 29 March visit to Chartered Accountants House, the importance of engagement from a wide cohort of members to help ensure that all views are taken into consideration when deciding whether the proposed amendments are appropriate. 

With this in mind, accountants are advised to familiarise themselves with the proposed changes and consider how these changes might impact their clients. 

Anyone who wishes to issue a response to the FRC on FRED 82 can do so via its website. The comment period remains open until 30 April and the FRC has proposed an effective date of accounting periods beginning on or after 1 January 2025 for the changes.