1. Financial Instruments & foreign currency
- FRS 102 introduces a distinction between “basic” and “other” financial instruments. Instruments, other than basic financial instruments, will be measured at fair value
- Monetary items denominated in foreign currencies must be carried at the current exchange rates and cannot be carried at a forward contract rate as is currently allowed. The related foreign exchange forward contracts, typically held off-balance sheet under Existing GAAP, must be recognised on balance sheet at fair value
- Hedge accounting requirements may allow for mitigation of the volatility impact on earnings but will impose requirements in respect of documentation and testing
- Functional currency determination, particularly in respect of special purpose entities and intermediate holding companies, will be subject to more stringent assessment
- Provisions for impairment will be made on the basis of incurred losses based on objective evidence
- Certain transactions involving purchases and / or sales of non- financial items where they are not for ‘own - use’ may need to be carried at fair value.
- Potential for significant earnings volatility, particularly for entities who have not previously adopted FRS 26
- Items such as options, rights, warrants, futures, forward contracts, interest rate swaps, convertible instruments etc. will now need to be recognised on balance sheet at fair value where either cost or off-balance sheet treatment may have been previously applied
- Existing FRS 26 users will have some additional items recognised at fair value, with no Held-to-Maturity and no Available-for-Sale categories
- Applying hedge accounting will provide opportunities to reduce P&L volatility for many. However, entities without experience of applying fair value measurement and hedge accounting will be subject to new disciplines requiring investment in resources, systems and training
- Where existing determinations regarding functional currencies are altered, items not previously subject to retranslation – including external and intra-group debt – may now give rise to volatility. Group funding and other structures may need to be re-assessed
- Maintaining general provisions or provisions based on expected losses is not permitted, and some entities may not be able to retain existing levels of provisions.
2. Business combinations & goodwill
- More separately recognised intangible assets are likely to be recognised and amortised over finite useful lives
- The rebuttable presumption for the useful life of goodwill has been reduced to five years, unless evidence supports longer lives – amortised over that life
- Required to test for impairment where indicator exists
- Acquisition accounting applied to all transactions except in the case of Group reconstructions
- Transaction costs will be capitalised as part of the cost of the combination.
- Expertise required to separately identify and value acquired intangible assets is unlikely to be readily available internally in most entities
- Neither goodwill nor intangible assets are permitted to have indefinite useful lives. This, together with shorter amortisation lives generally, could negatively impact on reported earnings of acquisitive entities in the early years after acquisitions.
3. Leases and transactions containing embedded leases
- Agreements that transfer the right to use assets and which are not in the legal form of a lease may, for accounting purposes, be determined to be or contain leases
- Entities will need to examine carefully arrangements they may have for procuring or providing certain services – particularly with respect to outsourcing – which are dependent on specified assets or take-or-pay arrangements
- Lease incentives (e.g. rent free periods) will be recognised over the life of a lease. This may change the pattern of recognition of the lease expense since incentives were typically recognised up to the first break period previously
- Some additional judgement in lease classification applies: the 90 percent “bright” line for distinguishing operating and finance leases no longer applies.
4. Deferred tax
- Fewer exemptions are available with respect to recognition of deferred tax liabilities. For example, deferred tax will need to be recognised in respect of revalued property, regardless of any intention to sell the asset where Existing GAAP provided an exemption in this respect
- Deferred tax will be required on fair value adjustments made in a business combination
- Current and deferred tax will be measured based on rates which apply to undistributed income, a consequence of which will be to recognise close company surcharges in Ireland until such time as the distributions to avoid such charges is made
- FRS 102 and IFRS requirements diverge materially: FRS 102 requirements are based on the “timing differences plus” approach which looks at reported comprehensive income as compared to taxable profits in a manner similar to current GAAP. The IFRS approach is based on “temporary differences” or a balance sheet derived approach.
5. Investment properties
- Definition includes properties let to and used by fellow group companies
- Recognised on balance sheet at fair value with changes in value recognised in P&L
- ‘Existing’ use valuations will not be permitted - fair value based on open-market price
- Volatility may arise as a result in reported earnings
- Valuations will need to include “highest and best use” value.
6. Defined benefit pension schemes
- The deficit or surplus relating to a group defined benefit pension scheme will no longer be permitted to be recognised only in the group accounts
- Where group companies cannot individually account for their portion of the surplus/deficit, the total must be recognised in the sponsoring company’s accounts.