Eddy James talks to Danielle Stewart OBE, partner and Head of Financial Reporting at RSM, about proposed amendments to UK GAAP.
Late last year, the Financial Reporting Council (FRC) issued FRED 82 ‘Draft amendments to FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland and other FRSs – Periodic Review’, an exposure draft setting out proposals to make a number of significant changes to FRS 102 and other elements of UK GAAP, in order to keep it closely aligned with international financial reporting standards (IFRS). The proposals would introduce, among other things, a new approach to accounting for both revenue and leases (for more details of the proposals, see Periodic review results in proposals for major changes to UK GAAP). FRED 82 is a hefty document, filled with page after page of marked-up text. Unless you’re a financial reporting expert, it’s not a straightforward read and it’s easy to get lost in the detail.
So we decided to speak to an expert – Danielle Stewart, partner and Head of Financial Reporting at RSM – to find out what the big issues are and what impact the proposals are likely to have in practice. Stewart has spent her career working with fast-growing mid-market businesses and received an OBE in 2013 in recognition of her life-long service to developing accountancy regulations and standards; she is known for being able to explain complex ideas simply. Stewart is also a member of ICAEW’s Financial Reporting Committee and is chairing the working party that is putting together ICAEW’s response to the proposals (although the views expressed in this article are her own). Here’s what she had to say to help you make sense of it all.
Speaking the same language
We begin by asking her whether the proposals are a good thing. Her response is effusive: “Keeping UK GAAP in line with international standards is very desirable, more so today than ever. In an increasingly global marketplace, it is important that businesses speak the same language. Having consistent standards makes it easier for everyone – preparers, users and auditors of the financial statements all benefit, as do accountancy students, who only have one set of rules to worry about. If UK standards are different from international ones, there is more room for error. Simplicity ultimately comes from following international standards.”
But we all know that IFRS can sometimes be very complicated to apply in practice. Isn’t bringing its requirements into UK GAAP going to create more complexity rather than less? Stewart doesn’t think so: “The proposals don’t bring in IFRS word for word. The FRC has taken a very pragmatic approach and has simplified some of the more challenging areas to make them easier to apply in practice. It has generally done a really good job of this and has written the proposals with an eye on the fact that the typical FRS 102 preparer is not overly familiar with IFRS.”
A new way of thinking
We’re keen to talk about the proposals relating to revenue recognition as revenue is, of course, such a key number in any set of financial statements. The proposals introduce a new model based on IFRS 15 Revenue from Contracts with Customers, a standard that has a reputation for being one of the most challenging to apply in practice, so should people be worried? Stewart is reassuring: “The proposals introduce a rigorous new approach to revenue recognition, but I very much welcome the change and encourage people to embrace it. The current revenue recognition requirements in UK GAAP are lacking in detail, as a result of which it is often impossible to tell how to account for the more complex transactions we see in modern businesses. The proposals are much more comprehensive, which is a good thing – having more guidance makes life easier rather than harder. It is a new way of thinking about revenue recognition and it may take a little while to get used to it, yet for many straightforward businesses it won’t actually affect how much revenue they recognise or when they recognise it.”
The proposals are much more comprehensive, which is a good thing – having more guidance makes life easier rather than harder
She goes on to commend the FRC on the work it has done in this area: “The FRC deserves a lot of praise for making the principles of IFRS 15 much easier to understand. The five-step approach to revenue recognition inherent in the international standard is made more explicit, making it easy for users to follow and apply. I really like the redraft of the guidance on variable consideration too – it’s simpler to apply than the IFRS equivalent . I love the way that the FRC is giving users the help that they need to apply the standard in practice. Obviously, the proposals aren’t perfect – for example, they may have introduced some unintended differences to IFRS, particularly when it comes to issues such as determining whether or not revenue should be recognised over time and assessing whether an entity is acting as a principle or an agent. But I’m hopeful these problems can be fixed before the standard is finalised.”
Dispelling the myth
Another area where significant changes are proposed is accounting for leases. Under current UK GAAP, many leases are classified as operating leases and remain off-balance sheet. Under the proposals, based on IFRS 16 Leases, many leases will come on balance sheet for the first time. Some have expressed concerns that this will be very complicated and time consuming, but Stewart is keen to dispel these myths: “I think the changes in relation to leases have been over-hyped. It’s a shame that the FRC couldn’t find a way to make the wording simpler in this area, as it does look complex at first glance. But in reality, for many simple leases, the accounting will be no different to how we account for finance leases today. Most companies will end up with their balance sheet being grossed up to some extent, with an additional asset and a corresponding lease liability being recognised. The asset will be called something different – a right-of-use asset – yet the accounting is fundamentally the same as finance lease accounting, unless you have complications such as variable lease payments or variable lease terms.”
In reality, for many simple leases, the accounting will be no different to how we account for finance leases today
Stewart is keen to point out that the FRC has included some simplifications to IFRS 16’s leasing model to make it easier and more cost-effective to apply: “IFRS 16 allows entities an option to leave leases of low-value assets off balance sheet, but there is no guidance in the standard itself on what is meant by low-value. The basis for conclusions accompanying the standard does, however, mention that the International Accounting Standards Board had leases of assets with a value of US$5,000 or less in mind when drafting this requirement. The FRC’s proposals are much more explicit on this point, giving examples of assets that would typically be considered low-value – such as personal computers, mobile phones and portable power tools – and examples of items that would not be considered low-value, such as land, buildings and vehicles.”
She continues: “Another important simplification relates to how the discount rate is established where the rate implicit in the lease cannot be readily determined. In such cases, IFRS 16 requires the lessee to use its incremental borrowing rate. Working this out can be incredibly complex in practice. The FRC’s proposals would instead allow the lessee to use its obtainable borrowing rate – the rate of interest at which a lessee could borrow, over a similar term, an amount equal to or greater than the total undiscounted value of the lease payments to be included in the measurement of the lease liability. This should be much easier to determine – just phone up your bank and ask. In exceptional cases, where none of these rates can be readily determined, the proposals even allow an entity to use a suitable gilt rate to discount the lease payments back to present value.”
Finally, she adds: “Practical expedients are also proposed for first-time adoption of the new requirements to make transition easier. It’s also worth noting that the very smallest of entities – those that apply FRS 105 – will not be required to apply the new leasing model. All of these simplifications – which are largely optional – provide really practical help for those preparing financial statements, something I really love!”
Despite all that the FRC has done to simplify them, there is no doubt that implementing these proposals will still be a challenge for some businesses. Stewart is keen to encourage people to start planning for the changes that lie ahead: “While the amendments are still only proposals – subject to public consultation and change before being finalised – the direction of travel is clear and it’s best to start planning for the transition as early as possible. Doing so will lessen the pressure as any implementation date approaches. If you are not familiar with IFRS 15 or IFRS 16, you may need to undertake some training to get yourself up to speed. Ideally you should look to do this sooner rather than later. The good news is that there is plenty of guidance from the international implementation experience out there, including some great resources from the Corporate Reporting Faculty.”
The proposed effective date of the amendments is accounting periods beginning on or after 1 January 2025. Will this give people enough time to prepare for the changes that lie ahead? Stewart thinks so: “In my opinion, there will be plenty of time for businesses to prepare for the changes. There is nothing to be gained by delaying implementation – experience shows that there’s little point in giving people more time as they’ll just leave it to the last minute anyway. So, I strongly believe that it is better to get on with implementing these changes sooner rather than later.”
Summing up, she concludes: “These changes are undoubtedly significant and implementing them will not be without its challenges. However, I believe we should really embrace them, as they will not only ensure consistency with IFRS, but will also improve the quality of the information in the financial statements. The FRC has done a great job of ensuring that the proposals are as easy as possible to apply in practice. It has also thought hard about the preparer by making their guidance as practical as possible. So maybe it won’t be quite as scary as you might think.”
The views expressed in this article are those of Danielle Stewart OBE. See FRED 82: ICAEW’s initial views for ICAEW’s preliminary thoughts on the proposals.
Eddy James, External Adviser on Corporate Reporting (Contractor)