Major accounting changes proposed by the Financial Reporting Council

If your finance team produce your company’s financial statements using the FRS 102 and FRS 105 accounting frameworks, you need to be aware of some significant proposals that have just been consulted on by the Financial Reporting Council (FRC). 

The consultation closed at the end of April and MHA Moore and Smalley commented on the proposals along with other entities such as the ICAEW. The two key changes are set out in brief in this article but for further detail on all the suggestions, please refer to the ‘FRED 82’ (financial reporting exposure draft) on the FRC’s website.

Two major changes – leases and revenue

The two main changes are to the accounting of leases and to how revenue is treated and recognised in the financial statements. For leases, currently only suggested for FRS 102, a new section 20 sets out a ‘right-of-use’ model, based on the accounting for leases already in place in IFRS 16. This means that if your company has control over, or a right to use, an asset it is renting, it is classified as a lease for accounting purposes and under the new rules must therefore be recognised on your company’s balance sheet.

Under the current accounting standard, significant financial liabilities can be held off-balance sheet as operating leases. The objective of the proposals is to ensure that companies report information for all of their leased assets in a standardised way and consequently provide greater transparency over companies’ lease assets and liabilities.

Two exceptions have been proposed, but it is unknown whether they will make it to the final version of the revised Standard: companies may choose not to apply the requirements to short-term leases, which is defined as 12 months or less in IFRS 16; or to ‘low value’ leases, which could include mobile phones and PCs.

Complications may include ‘inherent leases’ in contracts, and as soon as the revised standard is released later this year, we strongly encourage your finance teams to start looking at any contracts that your company has as this may be a time-consuming exercise.

The proposals for the change to how revenue is recognised would apply to both FRS 102 and FRS 105 and again, reflect the accounting that has been in place in the relevant international standard (IFRS 15) for the last few years.

The basis of the changes are to recognise revenue when control over the goods or service is transferred to the customer. There are five stages that finance teams need to go through, step by step, which are:

1. Identify the contract(s) with a customer
2. Identify the promises in the contract
3. Determine the transaction price
4. Allocate the transaction price to the promises in the contract
5. Recognise revenue when (or as) the entity satisfies a promise.

The term ‘promises’ has replaced ‘performance obligation’ as used in IFRS 15, but it is unsure whether it will be retained in the final version of the revised Standards.

Again, there are possible complications to this process that companies should bear in mind now. Contracts may be combined if they have been entered into at, or near, the same time with the same customer or related parties of the customer and specific criteria will be set out for this. Warranties can also be problematic when accounting for revenue in this way – if you provide goods or services with a warranty, you will need to focus on these.

There are other specific considerations relating to this proposed change, as well as for all the other, less significant ‘incremental’ proposals, and finance teams are encouraged to read the proposals now to gain an understanding of what may end up in the final versions of the Standards, not least because the proposed effective date for the revisions is for periods starting on or after 1 January 2025.