Difference Between FRS102 & FRS105 (UK Accounting)
Questions often arise as to the suitability of each standard depending on whether the client is a micro-entity or small entity.
At the outset it is worth noting FRS 105 is an optional standard. Just because a micro-entity may be eligible to use FRS 105 does not mean it has to (and there are genuine reasons why FRS 105 may not be appropriate to a micro-entity). FRS 105 should therefore be considered on a case-by-case basis.
FRS 102 contains a separate section in the form of Section 1A Small Entities. FRS 102, Section 1A only deals with the presentation and disclosure requirements for a small entity. Recognition and measurement principles are dealt with in full FRS 102. Hence, Section 1A is not a ‘one-stop-shop’.
The benefit of this is that if a small company outgrows Section 1A (ie it becomes, say, a medium-sized entity) then the disclosure requirements become more comprehensive as they will be based on individual sections of FRS 102 rather than Section 1A.
However, the recognition and measurement of amounts are still the same as when the company was small. Hence this avoids a transition to another alternative framework.
FRS 102, Section 1A contains the disclosures required by company law. The section itself is optional – a small company need not apply Section 1A if they do not wish to, although most small entities do choose to apply Section 1A in practice.
The same recognition and measurement principles will apply to all entities, regardless of size, that report under FRS 102
Therefore, an entity which qualifies as a micro-entity but chooses to report under FRS 102 will use the same recognition and measurement principles as a large entity. You cannot ‘cherry pick’ between standards so a micro-entity that chooses to report under FRS 102 cannot then apply certain provisions of FRS 105. It is one or the other.
There is one exception to full recognition and measurement principles which is available only to small entities (including small LLPs) in FRS 102, para 11.13A which relates to a loan to a small entity.
FRS 102, para 11.13A allows a small entity which receives a loan from a person who is within a director’s group of close family members (as defined in the Glossary to FRS 102), when that group of close family contains a least one shareholder, to recognise the loan at transaction price (i.e. at cost).
In practice, this would apply to a loan provided to a small entity that is covered by formal terms and which is at below market rates of interest. The exception in paragraph 11.13A means the small entity does not have to impute a market rate of interest and then discount the loan on initial recognition using that imputed rate of interest.
If the loan is not covered by formal loan terms (as is the case for most of these sorts of transactions within a small entity), then the loan would not be discounted anyway because it would be considered as being repayable on demand, so the loan would be recognised as a current liability in the small entity’s financial statements.
FRS 102, Section 1A, Appendix E Additional disclosures encouraged for small entities contains five encouraged disclosures which preparers cannot disregard.
Over the last 18 months, the most important one to consider is the going concern disclosure. FRS 102, Section 1A, para 1AE.1(c) encourages a small entity to provide the disclosures relating to material uncertainties [emphasis added] related to events or conditions that cast significant doubt upon the small entity’s ability to continue as a going concern as set out in paragraph 3.9.
This paragraph is important because going concern is such a fundamental concept. The fact that the paragraph encourages the small entity to disclose material uncertainties means that if the directors choose not to (on the basis that the disclosure is encouraged rather than legally required), it will be difficult to justify that the financial statements give a true and fair view. Hence, in the absence of such disclosures, the financial statements will contain material misstatement and will be misleading.
Keep in mind that professional bodies do not allow member firms to have their names associated with financial statements which are misleading, so this is a particularly important issue to consider.
FRS 105 is viewed as a ‘compliance framework’ rather than a ‘true and fair framework’. The standard is prescriptive and includes much simpler recognition and measurement principles and a vastly reduced disclosure regime (for UK-based micro-entities at least). There is only one format permitted for the profit and loss account (a Format 2 profit and loss account which presents expenses by nature).
A notable feature of FRS 105 is the presumption in law that if the micro-entity’s financial statements are prepared in accordance with the minimum legal requirements (ie FRS 105), the financial statements give a true and fair view. This means the directors need not consider making any additional disclosures, beyond those required in the standard, to achieve a true and fair view.
Other notable simplifications in FRS 105 are shown in the following table:
|Borrowing and development costs||All borrowing and development costs must be expensed. There is no option to capitalise them.|
|Deferred tax||Micro-entities are prohibited from accounting for deferred tax.|
|Defined benefit pension plans||These are accounted for in the same way as defined contribution plans, ie contributions into the plan are accounted for as an expense. A liability is recognised in respect of any agreements to fund a deficit (a schedule of contributions) because the pension obligation is not reported on the micro-entity’s balance sheet.|
|Equity-settled share-based payments||Micro-entities need not account for equity-settled share-based payments prior to the issue of the shares (this is because of the prohibition in using fair values, noted below, and the lack of disclosure).|
|Financial instruments||Micro-entities are not required to use the amortised cost and effective interest method as they are considered to be too onerous, hence financial instruments are effectively recognised and measured at cost.|
|Foreign currency||There is no distinction between functional and presentation currency and the micro-entity must use contracted rates to translate assets and liabilities denoted in a foreign currency as opposed to closing rate.|
|Government grants||Government grants are measured under the accrual model. The performance method of grant recognition is prohibited under FRS 105.|
|Hyperinflation||The accounting issues relating to hyperinflation are not included in FRS 105 as hyperinflation is unlikely to be an issue for micro-entities.|
|Recognition of separately identifiable intangible assets in a trade and asset acquisition||This requirement is removed in FRS 105 because they are not required items in the financial statement formats.|
|Revaluations and fair value amounts||Micro-entities cannot revalue assets, nor can they apply fair value accounting. This is because use of the Alternative Accounting Rules and Fair Value Accounting Rules is prohibited in the micro-entities’ legislation.|
|Specialised activities||These consist only of agriculture. Activities such as extractive industries, service concessions, heritage assets and funding commitments are unlikely to apply to micro-entities.|
The above factors will help you to determine and help your clients on better understanding as well.
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