Simon Kettlewell explains how proposed changes to FRS 102 are likely to affect the millions of UK small businesses that take advantage of the reduced disclosures set out in Section 1A of the standard.
For small entities choosing to apply the small entities regime, Section 1A Small Entities of FRS 102 sets out the information to be presented and disclosed in their financial statements. Since its introduction in 2016, these simpler requirements have proved to be a popular option. Many small entities will therefore be interested in how 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 – will affect Section 1A.
The Financial Reporting Council’s (FRC) consultation stage impact assessment, published alongside FRED 82, shows that there are approximately 3.2 million companies that will be affected by its proposals, with 3.16 million of these being micro or small entities. While half of these prepare their financial statements under FRS 105, the other half use FRS 102. Any changes to Section 1A will therefore affect a substantial number of UK entities.
What are the current requirements?
In the extant version of Section 1A, Appendix C sets out the mandatory disclosure requirements for small entities in the UK and Appendix E sets out the additional encouraged disclosures, which may be necessary in order to give a true and fair view.
As a reminder, when relevant, the encouraged disclosures currently set out in Appendix E are:
- a statement of compliance with FRS 102 as set out in paragraph 3.3 of the standard, adapted to refer to Section 1A;
- a statement that the entity is a public benefit entity as set out in paragraph PBE3.3A of FRS 102;
- disclosures relating to material uncertainties related to events or conditions that cast significant doubt upon the small entity’s ability to continue as a going concern as set out in paragraph 3.9 of FRS 102;
- dividends declared and paid or payable during the period (for example, as set out in paragraph 6.5(b) of FRS 102); and
- on first-time adoption of FRS 102, an explanation of how the transition has affected the financial position and financial performance of the entity as set out in paragraph 35.13 of FRS 102.
When Section 1A was first introduced, the disclosures required for small companies were driven by the requirements of the EU Accounting Directive. The FRC was therefore unable to introduce any further mandatory disclosures, but was able to set out disclosures that were encouraged for the purpose of giving a true and fair view.
The FRC is now able to mandate – rather than encourage – additional disclosures in order to achieve a true and fair view
Following the UK’s exit from the European Union, the EU Accounting Directive no longer applies, meaning the FRC is now able to mandate – rather than encourage – additional disclosures in order to achieve a true and fair view. Consequently, FRED 82 includes a number of proposed changes for Section 1A reporters in the UK.
What’s being proposed?
First, it is proposed to move the previously encouraged disclosures from Appendix E (as set out above) into Appendix C, thereby making them mandatory.
Second, there are additional disclosures proposed that are linked to the changes on revenue recognition and lease accounting discussed in Periodic review results in proposals for major changes to UK GAAP. Additional disclosures are introduced into the ‘full’ version of FRS 102 as part of the proposed amendments to revenue recognition and lease accounting, with some of these also being included in Section 1A. For example, in respect of leases, the proposed Section 1A would require:
- A general description of significant leasing arrangements, as set out in paragraph 20.85.
- The disclosures relating to short-term leases, leases of low value assets and variable lease payments as set out in paragraphs 20.86(c) to (e).
- Application of the ‘usual’ fixed asset disclosure requirements to right-of-use assets recognised under the new leases model, including those that apply to assets held at revalued amounts, where appropriate.
- Additional ‘off balance sheet arrangements’ disclosures to include leases for which recognition exemptions have been taken.
Finally, the FRC has also taken the opportunity to introduce a number of additional disclosure requirements:
- Confirmation of the use of the going concern basis and consideration of information about the future, as set out in paragraph 3.8A (this is also a new requirement in full FRS 102).
- The disclosures relating to provisions and contingencies as set out in paragraphs 21.14 to 21.17A.
- The disclosures relating to share-based payments set out in paragraphs 26.18 and 26.23.
- The deferred tax disclosures set out in 29.27(c), 29.27(e) and 29.27(f).
In regard to related party disclosures, it is not entirely clear whether a change in requirements is being suggested or not. It therefore remains to be seen whether Section 1A will continue to only require disclosure of material transactions with specified related parties that have not been concluded under normal market conditions, or whether fuller disclosures of all related parties will be required.
What’s the likely overall impact?
The combined effect of these proposals could be a fairly substantial increase in the length of financial statements prepared under Section 1A – something many preparers may not welcome. The most contentious change is likely to be the requirement for the mandatory disclosure of dividends.
The proposed amendment to Section 1A will mandate that dividends declared and paid or payable during the period are disclosed
Small entities reporting under Section 1A do not need to include a statement of changes in equity in their financial statements and a significant number of small entities do not currently include the ‘encouraged’ disclosure in respect of dividends. However, the proposed amendment to Section 1A will mandate that dividends declared and paid or payable during the period are disclosed. Difficult questions may follow about the fact that dividends paid to director-shareholders in owner-managed businesses will therefore be made public.
It is also likely that debate about the extent to which dividend payments to a small entity’s directors represent ‘normal market conditions’ will re-commence. While payment by way of dividend at a level considered an appropriate remuneration for business performance may not be a disclosable related party transaction, the total will still need to be disclosed as dividends paid.
Agree or disagree?
With the amendments to FRS 102 open for comment until 30 April 2023, time will tell how small businesses react to the proposals. Whether you agree or disagree with the changes, make sure your voice is heard by responding to the consultation.
Alternatively, you can respond to the FRC directly by visiting frc.org.uk/fred82.
Simon Kettlewell, Director, HAT Group of Accountants