The triennial review of FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland has made a number of amendments to the standard that are effective from 1 January 2019. With preparers and their advisers considering the impact of these changes, now seems like a perfect opportunity to also look back at the application of FRS 102 to date and identify areas where the quality of reporting could be improved.
Cash flow statement
The cash flow statement is often criticised by the FRC. In their recent publication Corporate Reporting Thematic Review: Small Listed and AIM Quoted Companies (November 2018), their primary concern was the classification of items. FRS 102, like IFRS, requires the allocation of cash flows to three headings: operating, investing and financing, based on the definitions below.
| Operating activities: |
The principal revenue-producing activities of the entity. |
| Investing activities: |
The acquisition and disposal of long-term assets and other investments not included in cash equivalents |
| Financing activities: |
The activities that result in changes in the size and composition of the contributed equity and borrowings of an entity |
Development costs
The definition of investing activities refers to the acquisition of an asset or other investment. In other words, for a cash flow to be investing it requires an asset to be recognised – something clearly stated in the equivalent international standard, but only implied in FRS 102. This means, given the accounting policy choice in FRS 102, a company choosing to capitalise development costs as an intangible asset will show the associated cash flows as investing, while a company that chooses to expense development costs would show those cash flows as operating.
Acquisition of a non-controlling interest
In a consolidated cash flow statement, the cash spent acquiring an interest in a subsidiary, associate or joint venture is recognised as an investing activity. However, the acquisition of a non-controlling interest in a subsidiary is classified as a financing activity. This is because the acquisition is treated in FRS 102 as a transaction between different equity holders (Section 22, paragraph 19) and as such changes the size of equity.
Profit, OCI or equity?
All movements in net assets have to be reported either in one of the performance statements (profit or loss or other comprehensive income) or in the statement of changes in equity. A basic principle exists, set out in Section 2, paragraph 23 to determine which of these two the movement should be in.
The principle is that transactions are recognised in the performance statements unless it is a transaction with a shareholder in their capacity as such. To illustrate, a cash dividend paid to a shareholder results in a reduction to cash and is a transaction with a shareholder in their capacity as such. The resulting debit would therefore be recognised in the statement of changes in equity.
The distinction between profit or loss and other comprehensive income however, is not quite so principles-based. In fact I don’t believe there even is one! Instead, the starting point is that all gains and losses should be recognised in profit or loss unless a specific provision of the standard requires those gains and losses to be recognised in other comprehensive income (Section 2, paragraph 44).
Therefore, once you have identified that a movement in net assets is a gain or loss, and not a transaction with a shareholder in their capacity as such, you have to look to the relevant section of the standard to determine whether it requires that gain or loss to be taken to other comprehensive income.
For example, the revaluation of an item of property, plant and equipment should be taken to other comprehensive income, unless:
- the revaluation results in the asset being recognised at less than depreciated historic cost, in which case the impairment below depreciated historic cost is recognised in profit or loss; or
- it results in the reversal of a loss previously recognised in profit or loss for that same asset, in which case it is recognised in profit or loss to the extent of that previous loss and thereafter in other comprehensive income.
However, revaluations of investment property are all taken to profit or loss and are never recognised in other comprehensive income.
The other thing to bear in mind when classifying gains and losses between the performance statements, is that any related deferred tax will be recognised in the same performance statement as the gain or loss. For example, deferred tax arising on the revaluation of an item of property, plant and equipment would be recognised in other comprehensive income if the revaluation is recognised in other comprehensive income.
If you fancy testing yourself, have a go at these questions. Answers are below.
Judgements and estimates
In its publication Corporate Reporting Thematic Review: Judgements and Estimates (November 2017), the FRC identified that entities often confuse judgements with estimates and vice versa. Does this matter? Yes, because the actual disclosures required depend on whether the matter at hand is a judgement or an estimate (Section 8, paragraphs 6 and 7). For me, the simplest way to think about it is whether or not the judgement being considered involves making an estimate. If an estimate is involved, for example the likely outflow for a provision, then the disclosures on estimates apply. If the judgement is about how to apply an accounting policy however, for example whether the entity is acting as an agent or principal in making a sale, and does not involve making an estimate, the judgement disclosures apply. The FRC also pointed out in its report that management needs to exercise discrimination in determining what judgements and estimates to disclose. Financial statements would become cluttered if every judgement and estimate were disclosed. Instead, an entity should only disclose information about:
- those judgements that have the most significant effect on the amounts recognised in the financial statements; and
- those estimates that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year.
Conclusion
Companies have been through three, nearly four, reporting cycles now of using FRS 102. As you think about applying the triennial review amendments from 1 January, it’s a good time to reflect on the quality of your reporting to date and see whether general improvements can also be made. The thematic reviews published by the FRC are a good place to start. Also, I’ve only discussed my view of three issues in this article. In March, I co-presented a webinar with Danielle Stewart OBE, of RSM, which counted down our thoughts on the current top 10 hot topics in UK GAAP. To find out what other topics made it into the countdown, a recording is available at icaew.com/frfwebinars
If you’d like more on the triennial review amendments to FRS 102, visit the faculty’s resources at icaew.com/triennialreview
About the author
Jake Green is a technical partner at Grant Thornton
