There are a number of areas that FRS102 is changing in UK GAAP which will have an impact on transactions and other corporate finance work.
A key change in the new GAAP in the UK as a result of FRS102 is the valuation of many assets at Fair Value including investment properties, some financial instruments, biological assets and investments in associates and joint ventures. In addition, the movements in fair value in these items each year are taken to the profit and loss account, rather than the movements being accounted for through reserves.
With the movements being within the main profit and loss account, now called the Statement of Comprehensive Income, there will be new items which will impact on the profits of the business which previously have not.
Under FRS102, exceptional items are not to be separately disclosed on the face of the Statement of Comprehensive Income. As a result, in considering the financial statements, further review of the accompanying notes or questioning of the company Directors is required to fully understand any fluctuations in performance and whether this is due to Fair Value movements, exceptional items, business or economic cycles or other factors.
The rules in relation to the recognition of Goodwill are now much stricter in terms of the separate identification of any intangible assets in a business combination. Identification and valuation of items such as customer databases, domain names, licenses, software, customer relationships and other items must now be valued and separately recognised in a business combination, even if they were not or could not be recognised in the business being acquired.
With the changes in the tax treatment of goodwill amortisation in 2015, acquirers will be much keener to separately identify intangible assets, as goodwill amortisation is now not allowable for tax, but amortisation of these identified intangibles is.
However, there remains the issue of valuation of these intangibles, with the most likely being the present value of future cashflows from them.
Basic financial instruments such as bank loans, or loans between connected parties are valued at amortised cost. For loans at lower than market rates of interest, this may mean that the amount included in the balance sheet are shown at less than the absolute loan amount, as an amount for “deemed” interest is calculated based on market rates. The impact on the balance sheet can be minimised or managed through their treatment and the nature of any loans in this category made need more consideration than previously.
Other financial instruments, which may have previously not been included in the financial statements at all, such as forward contracts, swaps and collars must be valued at Fair Value, with movements being accounted for within the Statement of Comprehensive Income. This adds a further fluctuation to the earnings calculations, but also better reflects the reality of a business’ risk to importing and exporting.
All financial statements for a period ending on or after 1 January 2016 now have to be prepared under FRS102 rules, with the comparative figures also being presented in accordance with new UK GAAP, and therefore amended from their original presentation as appropriate.
These first financial statements are required to present specific disclosures on the impact of FRS102 on the current and comparative figures, with any discovered errors disclosed separately. These will need careful consideration, particularly if they need to be compared with any earlier financial statements, for example, in valuing a company.
The impact on the profit, maintainability of the profit and the trends exhibited in the figures will all need careful consideration, particularly when comparing with historical figures. The second set of financial statements published under FRS102 will result in a 3 year period of profits compared on a consistent basis, which will start to provide evidence of trends under the new rules but the transition impacts will not be highlighted in this 2nd set of accounts.
Considerations for Corporate Finance
The 2nd set of FRS102 financial statements will start to show the trends in performance under the new rules, but they will fluctuate more and may be more difficult to assess than under the previous UK GAAP.
Particular areas where additional care will be required will include:
- the fluctuations in profits which therefore impact on the view of maintainable earnings, particularly with understanding what items may be considered exceptional or outside of normal trade as a result of changes in value hitting the profit or certain financial instruments being recognised for the first time;
- definitions in transaction documents such as heads of terms and sale and purchase agreements of financial criteria such as Profit before Tax and EBITDA, net assets (particularly net current assets as a result of potential changes in the treatments of loans as a result of the impact);
- negotiations based on earnings, especially in transition period as a result of a smaller period of comparability or the need to present adjusted figures;
- bank covenants as existing provisions may be breached as a result of a change in the accounting rules rather than a change in the business risk and any new finance with covenants attached will need to be considered under the new rules or have a provision for a reconsideration once the impact of FRS102 is known;
- it is likely that there will be more adjustments to management accounts required to reach a statutory presentation and therefore clients will need to be advised on how to bring their internal reporting more in line or adjustments will need to be made for external presentation.
Much of this gives rise to more questions than it provides answers and therefore advice should be sought on both sides, particularly during this transitional period.
For more information or to be put in contact with your local representative, please contact Hannah Farmborough or call on 0207 429 4147.
Source: This article originally appeared on the blog of our member firm, Broomfield & Alexander.