Financial Reporting Standard 102 (FRS 102), the ‘all in one’ standard for most UK GAAP reporters, was first published by the Financial Reporting Council (FRC) in March 2013 and had to be applied by reporters with December 2015 year ends.
FRS 102 is subject to periodic reviews by the FRC which consider, amongst other things, whether changes are required to existing requirements or any developments that need to be brought within FRS 102. The latter includes International Financial Reporting Standards (IFRS) and, from past experience, those developments tend to filter their way into UK GAAP at some point. The initial periodic review of FRS 102 was finalised in December 2017 with revised FRS 102 applicable to December 2019 year ends.
A further five years down the line, the second periodic review of FRS 102 is taking place, resulting in an exposure draft, FRED 82 Draft amendments to FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland and other FRSs – Periodic Review. Whilst FRED 82 contains proposed amendments to FRS 103, FRS 104 and FRS 105, as well as FRS 102, it tends to be the latter which has more relevance for UK GAAP reporters.
The major changes to FRS 102 proposed by FRED 82 surround lease accounting and revenue recognition.
Over the years, there has been much debate as to whether operating leases would need to be brought onto the balance sheet. FRED 82 is proposing to follow the broad principles of IFRS 16 Leases whilst providing a number of optional simplifications. All leases are proposed to be recognised on the balance sheet as right-of-use fixed assets (with the exception of short-term and low-value leases) together with a lease liability. There would be, in essence, no distinction between operating and finance leases that we have in the extant version of FRS 102.
Depreciation would be charged on the right-of use fixed assets, typically over the lease term, and a finance cost arises on servicing the lease liability. If all things were equal this would be the same as the operating lease expense currently recorded under FRS 102.
Whilst moving to ‘on balance sheet’ lease accounting for all leases might present challenges for reporters in obtaining all the inputs for the lease model, it does present an opportunity for some. Those who report on an earnings before interest, tax, depreciation & amortisation (EBITDA) basis will note that an operating lease expense forms part of the calculation of EBITDA, whilst depreciation of the right-of-use fixed asset and interest cost on the lease liability does not.
So, moving to an ‘on balance sheet’ basis might be favourable for those looking to increase reported EBITDA.
Revenue recognition has also been an area of focus for some time. FRED 82 proposes adopting the five-step model for revenue recognition from IFRS 15 Revenue from Contracts with Customers but with some simplifications.
The five step model involves:
- Identifying the contract (or contracts) with a customer;
- Identifying the promises in the contract;
- Determining the transaction price;
- Allocating the transaction price to the promises in the contract; and
- Recognising revenue when (or as) the entity satisfies a promise.
The form of a reporter’s contracts with its customers will determine whether there is a change to revenue recognition.
In applying the changes for leasing and revenue recognition, FRED 82 does propose to allow the cumulative retrospective effect to be dealt with as an adjustment to opening equity or reserves at the date of the initial application, rather than a full restatement for prior years.
The proposal is that FRED 82 will be effective for accounting periods commencing on or after 1 January 2025, typically for December 2025 year ends.
The FRC’s consultation on FRED 82 closes on 30 April 2023 with publication of the final standard expected later in 2023.
Will the final standard mirror the proposal? Experience says that it broadly will, probably with a little bit of fine tuning.
As we all know, time can fly by and whilst 2025 seems some way off, reporters may need to consider the potential impact of FRED 82 on them and put in place strategies to deal with changes affecting them.