The Financial Reporting Council’s (FRC) draft amendments to UK GAAP, published in FRED 82 ‘Draft amendments to FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland and other FRSs – Periodic Review’, propose significant changes to the approach to revenue recognition and accounting for leases. Other proposed amendments include revisions to the standard’s section on concepts and pervasive principles, greater clarity to small entity disclosure requirements and the introduction of a new fair value measurement section. More details of the proposed changes can be found in Periodic review results in proposals for major changes to UK GAAP. ICAEW has been examining the proposals and here’s what is thought so far.

Broadly supportive of the proposed amendments

The FRC needs to ensure that the suite of UK GAAP standards is up to date and reflects the latest developments in international financial reporting standards (IFRS) as appropriate for users of UK GAAP standards. In ICAEW’s view, the proposed amendments generally meet that need effectively. It is clear there has been a significant amount of consideration put in to ensure that the proposals are consistent with IFRS without being ‘over the top’ for the type of entities using the standards.

Having reviewed the proposals in depth, ICAEW’s preliminary conclusion is that there are no fundamental concerns with FRED 82. That said, aside from some particular points of detail not covered in this article, there are areas that need further consideration as discussed below.

Lease accounting – it’s good but it’s not (quite) right

ICAEW has long supported on-balance sheet lease accounting – a lease commitment clearly fulfils the definition of a liability. IFRS 16 Leases was always going to be an obvious place to start when considering how to bring the same accounting concept into FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland. However, what is proposed in FRED 82 is almost the entire IFRS 16 standard – isn’t that a bit much for FRS 102? While some simplifications have been proposed, we question whether the result is somewhat disproportionate for a standard that aims to be simpler to understand and apply when compared with the international standards. 

This leads on to an arguably more difficult question – what can be done to make the section more concise and aligned with the rest of FRS 102? ICAEW has toyed with a number of ideas but fundamentally, reducing the length of the section will inevitably introduce accounting differences between FRS 102 and IFRS 16. This compromise might be one worth considering in more depth.

The FRC has introduced simplifications to lease accounting within the proposed amendments, such as the introduction of two additional types of interest rate that are not available to IFRS reporters for the purpose of discounting the lease liability. FRED 82 proposes that entities may be able to use the lessee’s obtainable borrowing rate for this purpose or, in exceptional cases, a gilt rate may be used. 

ICAEW is particularly supportive of the proposal to allow entities to use an obtainable borrowing rate to discount their lease liabilities, as it will be a rate that is far easier for entities to determine compared to the incremental borrowing rate, despite representing a broadly similar notion. Discounting lease liabilities using a gilt rate is unlikely to result in particularly comparable information. However, only allowing entities to use this rate in exceptional cases strikes the right balance between the need for comparability and the need to support entities in the practical application of this section of the standard.

Recognising concerns about the potential costs of the changes to lease accounting for the smallest entities, FRED 82 does not propose bringing the changes into FRS 105 The Financial Reporting Standard applicable to the Micro-Entities Regime at this stage; a decision that ICAEW supports. 

Is IFRS 15 too much for micro-entities?

ICAEW agrees with the proposals to align Section 23 Revenue of FRS 102 with IFRS 15 Revenue from Contracts with Customers and its five-step revenue recognition model. The existing guidance in the UK standard is out of date and arguably not adequate for accounting for anything beyond the simplest of revenue arrangements. ICAEW believes the approach taken by the FRC is the right one and the proposed simplifications are appropriate for FRS 102 reporters.

That said, there are certain areas of the proposals where the FRC has attempted to simplify the language from that used in IFRS 15 – referring to “promises” instead of “performance obligations” for example. However, doing so may result in users interpreting the wording in an inconsistent way and cause greater confusion. In these circumstances, ICAEW believes it might be better to stick with the existing language to avoid unintended consequences.

Also, unlike the lease proposals, the FRC has decided to introduce a further simplified version of IFRS 15 into FRS 105. In ICAEW’s view, this seems to be disproportionate for micro-entities and an inconsistent approach given the decision not to bring on-balance sheet lease accounting into FRS 105 at this juncture.

Deferring alignment with IFRS 9’s expected credit loss model is the right decision 

ICAEW agrees with the FRC’s decision to defer its conclusion as to whether to align FRS 102 with the expected credit loss (ECL) model of IFRS 9 Financial Instruments to a future date. Transitioning to an ECL model was a complex change for many IFRS reporters and therefore, given the other significant proposed amendments within FRED 82, this would be a step too far at this stage.

Although it is not being considered as part of this periodic review, the FRC’s preliminary view is that it may be appropriate to require certain entities to apply an ECL model to their financial assets measured at amortised cost but allow other entities to retain the incurred loss model – a view that ICAEW thinks is sensible. Credit risk is a significant component of pricing decisions for entities involved in lending, and therefore it would be appropriate for this type of entity to approach the impairment of their financial assets through the lens of an expected loss, rather than an incurred loss.

Effective date requires careful consideration

The proposed effective date for the amendments set out in FRED 82 is accounting periods beginning on or after 1 January 2025. Early adoption will be permitted provided all amendments are applied at the same time.

ICAEW acknowledges that, no matter what is decided regarding the effective date of the amendments, most FRS 102 reporters are not likely to consider the impact of the changes on their accounting and reporting processes until they start to prepare their first financial statements under the revised standard. For an effective date of 1 January 2025, this may not be until some point in 2026.

That said, the proposed changes in this exposure draft are significant and entities are likely to want an appropriate period of time to prepare adequately. Entities with complex revenue and leasing arrangements are likely to benefit from parallel running of their accounting processes in order to capture the right information throughout the whole comparative period. This is something they are not likely to be able to do given the proposed amendments will not be finalised until shortly before the end of 2023. 

There are also other factors that the FRC should consider before finalising the effective date, such as the time pressures on bodies that develop and maintain Statements of Recommended Practice plus training providers who will need to update their guidance.