FRS102 for property companies – The key changes

Accounting, Property

Property

The new Financial Reporting Standard known as FRS102 brings with it some fundamental accounting changes that impact on property companies and investors. The changes can bring different challenges to property valuations, investments, lease incentives and loans.

What is FRS102?

FRS102 is a new Financial Reporting Standard that will be adopted by most unlisted companies in the UK and possibly represents the single largest change of UK accounting practices for many years.

There is a phased period of adoption with large and medium sized companies required to adopt the standard for accounting periods commencing on or after 1 January 2015. This will be followed by all other companies with accounting periods commencing on or after 1 January 2016. As comparative figures also need to be restated in accordance with the new standard the first period affected will be 1 January 2014 when opening balances must be restated.

The new standard replaces all of the existing Statement of Accounting Practices (SSAPs), Financial Reporting Standards (FRSs) and Urgent Issue Task Force (UITF) directives. Some companies will be required to make significant changes in how they account for their transactions and recognise assets and liabilities. For others the impact of adopting FRS102 will be minimal. All will however be faced with increased disclosure in their financial statements.

Presentational Differences

The most striking change to accounts prepared under FRS102 will be presentational. The financial statements may now consist of an Income Statement (formerly the Profit and Loss account), a Statement of Comprehensive Income (formerly the Statement of Recognised Gains and Losses), a Statement of Cash Flows, a Statement of Financial Position (formerly the Balance Sheet) and a new primary Statement of Changes in Equity which brings to prominence information previous dealt with in the notes.

The new standard does allow more flexibility in the presentation of the accounts. It includes options to combine the Income Statement and Statement of Comprehensive Income and in some cases also combine the Statement of Changes in Equity into a Statement of Income and Retained Earnings. In addition the standard does allow other titles to be used for the primary statements. So companies may decide to retain the existing terminology if it’s not misleading.

Key Changes to Accounting Treatments for Property Companies

In addition to the presentational changes there are some fundamental changes to accounting treatment that may impact on property companies outlined below. Here we compare the old UK GAAP procedures with the new FRS102 standards.

1. Property Valuations:

i) UK GAAP

Property used in the business could be revalued or held at depreciated cost. If the revaluation model was used a full valuation was required at least every five years with an interim revaluation in year three, appreciation in value was taken to a revaluation reserve and unless there was a binding sale agreement in place there was no requirement to provide for deferred tax arising on disposal.

ii) FRS102

Such property can still be revalued but if this treatment is adopted, future revaluations must take place to ensure that the carrying value is not materially different from the fair value of the property. All revaluation differences are taken to profit and loss rather than a revaluation reserve and in all cases deferred taxation must be provided on all revaluation differences.

The result is that for companies that chose to revalue property, an annual valuation may be needed. Deferred tax will reduce the uplift in net assets arising from revaluation gains and the profit and loss reserve will be a mix of both distributable and non-distributable reserves.

The adoption of FRS102 does provide an opportunity for some companies to enhance the value of their net assets as it is possible to carry out a one-off valuation of tangible fixed assets and regard them as deemed cost going forward, without having to adopt a revaluation policy.  Even after the impact of accounting for deferred tax on the gain this could, in some cases, lead to a significant improvement to net asset value of the business.

2. Investment Property:

i) UK GAAP

Investment property was held at market value with movements in valuation taken to a revaluation reserve. There was no requirement to account for deferred tax on gains unless a property was subject to a sales agreement.

ii) FRS102

Investment property must now be held at fair value and movements in the valuation are taken to profit and loss. Deferred tax is provided on all revalued assets. The definition of investment properties has been widened to include properties occupied by other group entities in the single entity accounts.

The practical impact of the change is that reported profits will be affected by revaluation movements and reserves will be a mix of both distributable and non-distributable profits.  This is likely to lead to increased volatility of reported results.  Also the requirement to provide for deferred tax may reduce net assets especially in cases where there is a large historic revaluation reserve.

3. Lease Incentives:

i) UK GAAP

The value of lease incentives were recognised on a straight line basis up to the point when the lease resets to market rates (Commonly the first break clause).

ii) FRS102

Lease incentives are now recognised on a straight line basis over the term of the whole lease.

In practice this means profits in the lessee’s accounts will be reduced in the early period of the lease as an increased proportion of the lease incentive is deferred.  This may provide an advantageous tax cash flow benefit.

4. Loans bearing interest at below market rates:

i) UK GAAP

The capital element of such loans was treated as liabilities less capital repayments. Interest was charged through the profit and loss account on an accrual in accordance with the terms of the loan.

ii) FRS102

The capital element of such loans was treated as liabilities less capital repayments. Interest was charged through the profit and loss account on an accrual in accordance with the terms of the loan.

The introduction of FRS102 means that loans carrying no interest or interest terms that are materially below market rates such as group loans, will be recorded at a discounted value that is lower than currently recognised under UK GAAP.  The difference will be treated as interest income when the loan is made with an interest expense charged in subsequent years.  It is possible that group may wish to treat “permanent” group debt as a capital contribution thus increasing the cost of investment in the parent and creating a capital reserve in the subsidiary company.

5. Loans with no fixed terms of repayment:

i) UK GAAP

Commonly intercompany loans and loans between related parties lack formal documentation of terms. Such loans may have been disclosed as repayable within one year or after one year depending on the circumstances. In both cases the loans were recognised as the capital or nominal value of the loan.

ii) FRS102

Without formal agreement of terms it is likely that the loan will be recognised at its nominal value as a liability due within one year. If the loan is formally deferred it will be discounted and measured at amortised cost but this may be difficult to determine especially when there are no fixed terms.

In practice this change may have a detrimental effect on net current assets when group debt has previously been treated as a long term liability.  Unless this debt is treated as a capital contribution as noted above it is recommended that formal terms are established and potentially a market rate of interest for the borrowing applied.  In some circumstances using a minimum notice period of 53 weeks may alleviate the issue as the loan will be treated as due after one year but the discounting impact may be immaterial.

Effect of FRS102 on property companies

As highlighted above the financial statements of property companies are very likely to be affected by the introductions of FRS102.  In certain circumstances this could have a detrimental impact on the business and affect banking covenants as reported profits are likely to become more volatile and the strength of the balance sheet may change.

If you would like to find out more changes brought about by the new standards, see our FRS102 FAQs

Feel free to get in touch with the property team at Price Bailey to help you understand how your business may be affected. We can provide guidance and advice on how best to manage the transition into the new reporting and accounting framework.

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