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| Old GAAP | FRS 102 | Further Comment on Differences |
| Financial Instruments | Basic Financial Instruments (S.11) | |
| a) Non-FRS 26 adopters For non-FRS 26 adopters, there was no applicable standard. Under old GAAP, financial assets were measured at the invoiced or issued amounts less provision for impairment. Financial liabilities and debt instruments were measured at the amount of the fund received/paid regardless of when it was payable and regardless of whether they were at non-market rates. They were not required to be present valued under any other old GAAP accounting standard. Any costs on obtaining a loan may have been recognised in the P&L when incurred. FRS 4 required these costs to be written off over the term of the instrument however this was not always applied in practice. | The diagram attached summarises the requirements of Section 11 with regard to the recognition and measurement of basic financial instruments under FRS 102. (Example 21A – Summary Of Recognition Criteria Under Section 11). All basic financial instruments excluding investments in non-puttable ordinary or preference shares are initially measured at transaction price net of transaction costs and are subsequently carried at amortised cost. Where a financing arrangement exists i.e. sales/purchases made at non-standard terms or where loans are provided/advanced at non market rates then the financing element needs to be separated and posted as finance income or expense using the effective interest rate method. Basic financial instruments coming within the scope of section 11 are: · cash; · demand and fixed term deposits; · commercial paper and bills; · notes, loan receivable and payable; · bonds and similar debt instruments; · accounts payable, accounts receivable; · investments in non-convertible preference shares, non-puttable ordinary and preference shares (which do not give anything above a significant influence); · commitments to make or receive a loan to another entity that cannot be settled net in cash; and · loans due to or from group companies, directors loan accounts. Section 11.9(a) states the primary conditions for a debt instrument that needs to be satisfied for the debt to be regarded as basic and so may be measured at amortised cost are: – The contractual return to the holder (the lender), assessed in the currency in which the debt instrument is denominated, is: a) a fixed amount; b) positive fixed rate or a positive variable rate; and c) or a combination of a positive or a negative fixed rate and a positive variable rate (e.g. LIBOR plus 200 basis points or LIBOR less 50 basis points, but not 500 basis points less LIBOR). | As non-FRS 26 adopters did not have a specific standard for financial instruments this will result in a number of transition adjustments particularly where a financing arrangement exists. Detailed in this section are the principal adjustments expected. Entities will need to assess loan agreements to determine whether they meet the definition of a basic financial instrument as detailed in Section 11.9(a) across, if not they must be fair valued which will result in a transition adjustment. |
| Debt instruments Initial measurement Under old GAAP financial assets were measured at the invoiced or issued amounts less provision for impairment. Financial liabilities and debt instruments were measured at the amount of the funds received/advanced regardless of when it was payable and regardless of whether they were at non-market rates. They were not required to be present valued under any other old GAAP accounting standard. | Debt instruments initial measurement Section 11.13 deals with initial recognition, and states (with the exception of non-convertible preference shares, non-puttable ordinary share or preference shares) the financial asset or liability is measured at the transaction price including transaction costs unless the arrangement in effect constitutes a financing arrangement. Therefore, for a loan received or a trade debtor balance, a company would record it at the value of the loan received or the value of the sales invoice issued net of costs. This would be similar for a payable position or a loan payable. Where amounts are payable/receivable within one year no present valuing is required (unless there is a financing arrangement). | Where there are no transaction costs and there is no financing arrangement, the carrying amount under old GAAP compared to FRS 102 should be the same, therefore there should be no adjustments required on transition. An example of this would be a loan received from a bank group company/related party where a market rate of interest is being charged, the carrying amount of the loan in the books under old GAAP and FRS 102 will be the same. For normal trade debtors, creditors, bank loans no transition adjustments will be required. |
| Old GAAP did not require the financing element to be accounted for instead the carrying amount was the transaction amount. | If a financing arrangement takes place which is at anything other than non-market rates then section 11.13 requires the company to measure the financial asset/liability at the present value of the future receipts/payments discounted at a market rate of interest for a similar debt i.e. the rate of interest that would be charged on such a receivable/payable if the company were to go to an outside party e.g. a bank etc. to get the credit. Even where a rate of interest has been charged, it still needs to be at market rates, so where a below market rate is applied, the difference between the market rate and the rate applied will have to be present valued accordingly. A debt instrument which is repayable on demand will be carried at the consideration received or the amount of the loan provided on initial recognition as the amortised cost equates to the same amount. Therefore, it is irrelevant as to whether a market rate or any rate is being applied to a loan which is repayable on demand. | Where loans are at non-market rates or where no interest is charged on the loan or if a very low interest rate is charged on the loan, if the amount is repayable on demand then no transition adjustments will be required. The carrying amount under old GAAP would equal the carrying amount under FRS 102 (loan carried at amount received/advanced net of repayment etc.) transaction costs would be expensed. Evidence will be required to prove the loan is actually repayable on demand. Under old GAAP, there was no requirement to carry the financial assets or liabilities at amortised cost. Therefore, on transition for financial assets and liabilities which were not derecognised under old GAAP, an entity will have to identify financial assets and liabilities where there is a financing transaction (e.g. a loan advanced/received at favourable rates and is not repayable on demand) and then determine the market rate on such loans at the date of drawdown/advancement. Then determination has to be made as to the amortised cost to be recognised on transition. For intercompany loans, it is unlikely that the adjustment will be allowable/taxable for tax purposes so therefore there may be no need for deferred tax to be reflected on these adjustments. A transition adjustment will be required where a financing element exists. Examples of where adjustments may arise are: · inter-company loans received / advanced at non-market rates (i.e. not repayable on demand). Where such loans are in existence at the date of transition then a transition adjustment will be required to determine the amortised cost. See attached an illustrative example of the journals required to account for such loans under FRS 102 on transition (Example 21 – Loans At Non-Market Rates On Transition): · related party loan at non-market rate not repayable on demand. See attached an illustrative example of the journals required to account for such loans under FRS 102 on transition (Example 21 – Related Party Company Loan At Non-Market Rates On Transition); · director loans at non market rates that are not repayable on demand. See attached an illustrative example of the journals required to account for such loans under FRS 102 on transition (Example 21 – Directors Loan At Non-Market Rates On Transition); · sales/purchases made on unusual credit terms. In this case the present value would be the cash price that would be charged or the rate a third party bank would charge. See attached an illustrative example of the journals required to account for such loans under FRS 102 on transition (Example 22 – Sale With Unusual Credit Terms); · where loans have been received/advanced since the date of transition similar adjustments will be required. See example attached showing how these should be accounted for (Example 23 – Intercompany Loans). |
| Subsequent measurement For non FRS 26 Adapters usually transaction costs on debt instruments were expensed to the profit and loss when incurred or otherwise written off on a straight line basis while ideally they should have been netted against the instrument. Repayments and drawdowns etc. were set against the financial liability/asset. | Subsequent measurement The debt instruments should be measured at amortised cost using the effective interest rate method at each reporting date. In effect if there are transaction costs then these transaction costs are charged/credited to the profit and loss over the life of the debt instrument or earlier if the period to which they relate is shorter. Entities shall adjust the carrying amount of the financial asset or financial liability to reflect revised cash flows due to early repayments etc. The revised cash flows are discounted at the original effective interest rate of the loan. The difference between the carrying amount after the repayment and the present value of the revised cash flows is debited/credited to interest expense/income. | Depending on how entities accounted for transaction costs on loans received/advanced, there may be transition adjustments in this area where transaction costs incurred are material. See application of this method in the example attached together with an example of how a change in cashflow estimates are accounted for (Example 24 – Loan At Market Rates With Transaction Costs). |
| There was no concept of amortised cost for non FRS 26 adopters. | Section 11.15 defines amortised cost at each reporting date as being net of the following amounts: · the amount at which the financial asset is measured at initial recognition; · minus any repayments of the principal; · plus or minus the cumulative amortisation using the effective interest method of any difference between the amount at initial recognition and the maturity amount; · minus, in the case of a financial asset, any reduction (directly or through the use of an allowance account) for impairment or collectability. | As discussed above this will result in differences on transition where transaction costs are material and were expensed immediately or on a straight line basis under old GAAP. Refer to the comments above. |
| For non-FRS 26 adopters, these are stated at cost less impairment. Fair valuing is not permitted. For non-FRS 26 adopters, fair valuing was not permitted unless the entity adopted FRS 26. Therefore, there was no concept of a hierarchy. | Section 11.14 (d) states that investments in non-convertible preference shares, non-puttable ordinary and preference shares are required to be measured at: · fair value if the shares are publically traded or their fair value can otherwise be measured reliably with changes in fair value recognised in the profit and loss; or · cost less impairment if fair value cannot be reliably measured. Section 11.27 to 11.32 details the hierarchy when using the fair value model and details the requirements that are needed in order to be able to use fair value. The order of preference is: · a quoted price for an identical asset; · the price of a recent transaction for an identical asset; · a suitable valuation technique. Under old GAAP where entities had not adopted FRS 26, investment in equities of this nature was accounted for at cost less impairment with an option to fair value if the company adopted FRS 26. Therefore, if an active market is present then it must fair value these equities under Section 11 at the date of transition. This will require a transition adjustment. | This is a significant difference as a result transition adjustment will arise. Under Section 11 where the investments are listed on the stock exchange or where other non-listed investments can be reliably measured in line with the requirements of Section 11, these should be accounted for at fair value on transition. Under old GAAP it is likely that these were carried at cost less impairment. The uplift in fair value will need to be recognised to reserves at the date of transition. Deferred tax will also need to be recognised on this uplift at the sales rate (CGT rate) assuming the investments were not impaired below cost previously. If they were impaired previously, deferred tax is recognised between the tax cost (inclusive of indexation provided it does not create a loss) and the fair value. See an example of the adjustment required on transition where these shares can be reliably measured. (Example 25 – Non-Puttable Ordinary Shares At Market Value). |
| Impairments For non FRS 26 adopters, there was no detailed guidance and on occasions guidance in FRS 26 was applied. Usually for fixed asset investments other than investments in subsidiaries, associates and joint ventures (which were within the scope of FRS 11), a permanent diminution in value must be recognised in the P&L once impairment indicators exist. Current assets were measured at lower of cost and net realisable value. Section 11 gives more detailed guidance. | Impairments Section 11.21 to 11.25 deals with impairment of financial assets. An impairment loss is recognised in the profit and loss where there is objective evidence of an impairment (incurred loss basis). Objective evidence that a financial asset or group of assets is impaired includes observable data that come to the attention of the holder of the asset about the following loss events: a) significant financial difficulty of the issuer or obligor; b) a breach of contract, such as a default or delinquency in interest or principal payments; c) the creditor, for economic or legal reasons relating to the debtor’s financial difficulty, granting to the debtor a concession that the creditor would not otherwise consider; d) it has become probable that the debtor will enter bankruptcy or other financial reorganisation; and e) observable data indicating that there has been a measurable decrease in the estimated future cash flows from a group of financial assets since the initial recognition of those assets, even though the decrease cannot yet be identified with the individual financial assets in the group, such as adverse national or local economic conditions or adverse changes in industry conditions. (Section 11.22). | Section 11 provides more detailed guidance on when an impairment should be booked. Before an impairment is booked (e.g. bad debt provision etc.) there has to be indicators of impairment at the balance sheet date. On transition entities should review to ensure impairments made to financial instruments under old GAAP meet the requirements as there was no specific guidance under old GAAP. Where there is supporting evidence based on past experience for a group of debtors and based on the ageing of the debts it would not be unreasonable for a bad debt provision to be allowed under the condition in Section 11.22(e) and therefore no adjustments would be expected on transition in this area. There is unlikely to be many transition adjustments with regard to impairments where the entity did not incur transaction costs and/or where a financing arrangement does not exist. However as a result of the requirement to carry debt instruments at amortised cost where material transaction costs and financing arrangements exist and financial instrument is not impaired in full, the way in which an impairment is calculated will differ under FRS 102 as the revised estimated cash flows will have to be present valued so that the amount of the impairment can be determined. See illustrative example attached of how such an impairment should be calculated (Example 26 – Impairment Of Debt Instruments). |
| Derecognition Derecognition of financial assets for non FRS 26 adopters was dealt with in FRS 5, where the substance of a transaction was considered. FRS 5 allowed linked presentation which is not allowed in FRS 102. | Derecognition Under Section 11.33 there is detailed guidance in relation to when an asset is to be derecognised but essentially it should come to the same answer as what would have been concluded under old GAAP. Financial assets are derecognised only when the rights to the cash flows from the asset have expired or are settled; or the entity has transferred all the risks and rewards of ownership, or where ownership is transferred but control is relinquished (Section 11.33). | Although the terminology is different there should be no real differences on transition with regard to derecognition of financial assets. |
| Derecognition of financial liabilities was not specifically dealt with in old GAAP instead FRS 5 approached liability derecognition as an issue of derecognition of a related asset. | Section 11 provides detailed guidance on when to derecognise a liability and section 11.36 states that it should only be derecognised when the obligation specified in the contract are discharged, cancelled or expired. The way in which the derecognition is accounted for depends on whether it is a modification or an extinguishment. See attached the guidance diagram for derecognition of assets and liabilities as per the rules under Section 11 (Example 28 – Guidance For Derecognition Of Assets And Liabilities). When assessing whether a substantial modification has occurred, judgement will be required. | Where an entity has standard liabilities where it is easy to determine that it has been derecognised, no differences should arise on transition to FRS 102. Differences may arise where future cash flows change from expectation and as a result an entity will have to assess whether the instrument has been substantially modified. If it has then the liability would have to be derecognised and the new liability recognised under the rules of Section 11. There were no such rules under old GAAP. See attached an example of how a modification would be determined and how this would be accounted for (Example 27 – Substantial Modification Of A Loan). |
| No detailed guidance for non FRS 26 adopters. Section 11 is the same for FRS 26 adopters. There was no concept of a modification. | If an existing borrower and lender exchange financial instruments with substantially different terms, the entities account for the transaction as an extinguishment of the original financial liability and the recognition of a new one. Also where a substantial modification to the terms on an existing financial liability is made then the original liability is extinguishment and a new liability is recognised (Section 11.37 & 11.38). If the modification is not substantial the expense is accelerated. This concept is new to Old GAAP preparers who did not adopt FRS 26. | As this is new to non FRS 26 adopters, where for example a loan is renegotiated with substantially different terms, then the previous loan is derecognised and new loan recognised at its amortised cost. The difference between the two is posted to the profit and loss account as a finance cost/expense. See example of such a calculation in Example 27 in the line above. |
| Disclosures Under old GAAP there were very little disclosures required for financial assets and liabilities unless scoped into FRS 13. | Disclosures The disclosures are a little more onerous and are detailed in 12.26 to 12.29A. | There are significantly more disclosures required under FRS 102 than under old GAAP. On transition entities should ensure they meet these disclosure requirements. See attached sample disclosures (Example 29 – Extract Of Notes To The Financial Statements – Financial Instruments Note Disclosures). |
| Not applicable. | Section 29 – Income tax – Likely to be deferred tax on any transition adjustments which arise as a result of fair valuing capital items at the date of transition e.g. fair value of investments. | Deferred tax is required to be recognised on all capital fair value adjustments, therefore on transition an adjustment will be required to recognise deferred tax on equity investments carried at fair value. An example of the deferred tax calculation on transition has been attached (Example 30 – Non-Puttable Ordinary Shares At Market Value). |
| b) FRS 26 adopters See analysis across. | Entities have an option to adopt IAS 39/IFRS 9 of IFRS or instead adopt Section 11 and 12. Where IFRS is adopted there will be no differences. b) FRS 26 adopters For FRS 26 adopters, the following differences arise where IAS39/IFRS9 is not adopted: · under FRS 102 there is a two tiered model compared to a third option under FRS 26 (fair value through other comprehensive income); · embedded derivatives do not exist under FRS 102; · for basic debt instruments the criteria to recognise them at amortised cost under FRS 102 are less stringent than FRS 26; · the disclosure requirements under FRS 102 are less onerous. | Entities have an option to adopt IAS 39/IFRS 9 of IFRS or instead adopt Section 11 and 12. Where IFRS is adopted there will be no differences. Where Section 11 and 12 are adopted, adjustments will be required on transition to derecognise embedded derivatives previously recognised and recognise more instruments at amortised cost. A review will need to be performed to assess what embedded derivative have been recognised under old GAAP. |
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