Getting Ready for the new GAAP

Peter Herbert and Maria Hallows

November 2014

2

Objective

• To update you on the introduction of FRS 102 and

the related SORP and on the latest thinking

regarding implementation issues.

3

Programme

• Recap on the revised framework.

• Narrative reporting – where we are and where we’re heading.

• Formats, terminology and disclosures.

• The primary statements.

• Fixed asset classification and valuation.

• Accounting for impairments.

• Grant accounting – different methods and when they’re used.

• Latest thinking on financial instruments.

• Multi-employer pension schemes.

• Specialist areas (e.g. HomeBuy, stock swaps).

• Practical steps when preparing for transition.

• The auditor’s perspective.

The new framework…

Listed groups

IFRS in consolidated

accounts

Everybody else!

FRS 101/102

Small private

companies

Micro-entities

FRSSE (effective Jan 2015)

Micro entities legislation

P/C

Now

1.1.15

1.1.15

Now

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5

The new standards

Standard Deals with

FRS 100 - Application of Financial

Reporting Requirements

• Which standard to apply

• Application of SORPs

• Statement of compliance

• Effective date

FRS 101– Reduced Disclosure

Framework

• List of disclosure exemptions from

full IFRS for ‘qualifying entities’

FRS 102– The FRS applicable in

the UK & RoI (was ‘FRSME’)

• Operational FRS derived from IFRS

for SMEs

• List of disclosure exemptions from

this FRS for ‘qualifying entities’

FRS 103 – Insurance Contracts • New standard for insurance

companies

• Applicable to entities with insurance

contracts applying FRS 102

6

FRSs 100-102 - Timeline

2012 2013 2014 2015

Transition

date

Mandatory

adoption;

Comparative

BS

First balance

sheet

(Early

adoption

allowed from

31/12/12)

FRS 100

& 101

issued

FRS 102

issued

7

The Housing SORP 2014

• Drafted alongside FRS 102

• Published September 2014

– Major consultation from Nov 2013

• FRC approved

• Relatively short – cross referencing

to FRS 102

• FRS 102 and Accounting Direction

take precedence

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Scope considerations

Applies to all RPs (charitable and non-charitable)

RPs apply this SORP, not Charities SORP

Unregistered providers apply Charities SORP

Almshouses and Abbeyfield societies not governed by LTA 1985 apply Charities SORP

Where IFRS applies, use this SORP as guidance unless it conflicts

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Key words…

MUST SHOULD

MAY GLOSSARY

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Narrative reporting – where we are

KPIs Governance

Social value

Value for money

Controls Risks

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Beever and Struthers 2014 Annual Review

• KPIs

– Range of financial and performance-based indicators.

– Trend towards disclosure of per unit management costs.

– Chief executive pay per home managed.

• Social value

– OFR disclosures have followed Social Value Act 2012.

• VFM

– Should follow HCA standard.

– Wide variability in approach/level of detail.

– Peer review.

– More focus on operating costs than ROI.

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Example VFM disclosures

Operating surplus Capital deployed Returns (%)

Rented housing £27.9M £674M 4.1

Shared ownership £10.4M £187M 5.6

Market rent (before

3% unrealised

gain)

£3.7M £103M 3.6

Student housing £3.6M £41M 8.8

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The new SORP

• Objectives – Provide information on social landlord and insight into main

objectives/strategies and principal risks.

– Complement, supplement and provide context for related financial information.

• > 5,000 homes – Detailed requirements – Report of the Board & Strategic

Report.

– Relaxation where subsidiary within a group.

– Less prescriptive than current OFR requirement.

• < 5,000 homes – Good practice to include commentary – commensurate with

size of business.

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The new SORP

• Statement on internal controls

– Not required – but considered best practice.

• Statement of board responsibilities

– Required by SORP.

• Other relevant regulation

– Take on board when drafting (e.g.) Strategic Report -

CA06.

FRS 102 - Primary statements

Statement of

comprehensive

income

Statement of

financial position

(CA06)

Statement of

changes in equity

Statement of cash

flows

Income statement

(CA06)

Other

comprehensive

income

Statement of income & retained earnings

(where only changes to equity = profit,

dividends & prior period adjustments)

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What the SORP says…

• SOCI – ‘Two statement approach’ prohibited by SORP.

• Cash flow statement: – 3 headings (operating – investing – financing).

– ‘Cash & cash equivalents’.

– Exemption for ‘qualifying entities’.

• Statement of changes in equity – Like reconciliation of movements in shareholders funds.

– Comparative required.

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• Accounting policies – Areas of judgement/estimation uncertainty.

• Statement of compliance – …with SORP and FRS 102.

• Operating lease commitments – Total NOT annual commitments.

• Consolidated accounts – Legal status and commercial relationship with group entities.

• Related party disclosures – Key management personnel compensation.

– Non-disclosure of names becomes possible.

Notable disclosures

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Investment property - definitions

Paragraph 16.2 FRS 102

Property (land or building or part of a building or both) held by the owner or by the lessee under a finance lease to earn rentals or for capital appreciation or both, rather than for:

a) Use in the production or supply of goods and services or for administrative purposes; or

b) Sale in the ordinary course of business.

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Paragraph 16.3a FRS 102

Property held primarily for the provision of social benefits shall not be classified as an investment property (IP) and shall be accounted for as property, plant and equipment (PPE).

Investment Property - Treatment

Initial

measurement

Subsequent measurement

Fair value reliably

measureable

without undue cost

or effort

Fair value not

reliably

measureable

without undue cost

or effort

Fair value

(changes in I&E)

Cost – depreciation

model

Cost (purchase price and

directly attributable

costs)

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PPE or IP?

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Relevant factors

• Is asset held for social benefit?

• Reason/purpose for holding

asset

• Earn rentals

• Capital appreciation

• Both

• Production/supply of goods

• Admin purposes

• Sale in ordinary course of

business

Non-relevant factors

• Overarching organisational

objectives

• Purpose for which housing

property profits are applied

(e.g. profits from market rented

housing reinvested in social

housing)

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21

Classification

PPE IP

General needs √

Shared ownership (rental element) √

Affordable homes √

Office accommodation √

Market rented properties √

Commercial properties √

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Scenarios

1. An RP rents out commercial property at below market rent.

2. A parent RP rents a property to its own subsidiary.

3. An RP has its headquarters in a desirable London suburb where property prices are high and growing.

4. An RP rents out two of its five floors to another company.

5. A community centre within a housing development is regularly hired out to local businesses and community groups.

Property, plant & equipment

Initial

measurement

Subsequent measurement

Cost model

Revalued amount

(if FV can be reliably

measured) – changes usually

in OCI

Cost –

depreciation -

impairment

FV – depreciation – impairment

Revalue with sufficient

regularity to ensure carrying

value does not materially differ

from fair value

SORP requires use of existing

use value for social housing

(EUV – SH)

Cost (purchase

price and directly

attributable costs)

May include

borrowing costs

OR

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Example

An RP chooses to measure its social housing properties at

valuation.

At the reporting date the housing properties are revalued

from £95m to £100M.

This increase is made up of a £5M downward revaluation

for new properties not previously revalued and an increase

in value of the remaining properties of £10M.

Grant of £0.75M for the new properties has been received.

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Solution

2016

(£000)

2015

(£000)

Other income - grant 750 X

Operating surplus X X

Interest receivable X X

Interest payable X X

Decrease in valuation of housing

properties

(5,000) X

Surplus for the year X X

Unrealised surplus on valuation of

housing properties

10,000 X

Transfer from I&E reserve

to revaluation reserve?

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Impairment Impair where CV > recoverable amount

Higher of

Fair value less costs to sell

Calculate for ‘cash generating units’ (individual schemes)

Amount obtainable from sale in arm’s length transaction

EUV-SH could be used to determine fair value

Value in use

Present value of future cash flows expected to be derived from the asset

Use service potential (VIU-

SP) – depreciated replacement cost

Cash flow-driven calculation as ‘practical expedient’

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Impairment indicators

28 28

Contamination or similar issues not identified as part of development planning

Change in government policy, regulation or legislation

Irreversible change in demand for a property

Material reduction in market value of properties

Obsolescence of a property

Not an exhaustive list – refer also to FRS 102

1. Determine level at which

impairment is to be assessed

2. Estimate recoverable amount of

asset or cash generating unit

3. Calculate carrying

amount (CA) of asset or cash

generating unit

4. Compare CA to recoverable

amount to determine if an impairment loss

has occurred

Step by step

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Cash generating unit

Smallest identifiable group of assets that generates cash

inflows that are largely independent of the cash

inflows from other assets or groups of assets

Cash inflows are inflows of cash and cash equivalents

received from parties external to the landlord

In identifying whether cash flows are independent,

consider factors such as how management organises

business activity or makes operational decisions

SORP considers it remote that a cash generating unit

would be all of a social landlord’s housing properties

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Value in Use – Service Potential

VIU SP =

Depreciated replacement cost (DSC)

Most economic cost required for the entity to replace the service potential of an asset

Lowest cost of constructing or buying a replacement asset which replaces the service potential

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Example

A development is made up of 10 x 2 bed properties and 10

x 3 bed properties. Total scheme cost £2.1M and £200K

received as grant. 50 year life.

Cost of construction = £90K per property (2 bed); £120K per

property (3 bed). Previously acquired land = £100K.

Two years later a change in legislation results in a new

requirement in respect of size of rental properties such that

3 bed properties can no longer be rented out.

3 bed properties can be rented as 2 bed properties.

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33

Carrying amount of 3 bed development

£000

Land cost 50

Building cost

Less depreciation

Less unamortised grant (96)

Carrying amount

34

Recoverable amount of 3 bed development

Fair value less costs to sell (£000)

Total 500

Depreciated replacement cost (£000)

Total land 50

Total buildings

Less depreciation

Total

Double entry?

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Depreciation adjustments

36

SORP para 14.9

‘Social landlords should review the remaining useful economic life, the depreciation

(amortisation) method and the residual value of an asset…even if no impairment loss is

recognised’.

Treatment of grants

Initial

measurement

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Recognition in SOCI

Performance

model

Accruals

model

Recognise in income

as specified future

performance

conditions are met

Recognise in SOCI

on systematic basis

over periods in which

entity recognises

related costs

Fair value of assets

received/receivable

Use for revalued

assets

OR

Use for non-revalued

assets

Do not deduct from fixed asset

Do not deduct from fixed

asset

Grant example

• On 1 April 2015 an RP purchases a property asset for £200K. It receives a grant of £150K.

• Assume land element =£ 60K; structure element = £120K (UEL: 100 years); other components = £20K (average UEL 10 years).

• What would the impact on I&E be in year one applying:

a) Current SORP.

b) New SORP / FRS 102 – accruals method

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Solution

Old SORP

£

New SORP

£

I&E:

Depreciation 2,200 dr

Grant income -

Grant amortisation -

Net impact (Dr/(Cr)) 2,200 dr

Recognition of grant

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Over EUL of

structure (NOT

land and

structure)

Over EUL of

structure and

components

(excluding

land) on pro-

rata basis

OR

No linkage to land

Financial instruments

• Definition:

• A contract giving a financial asset of one enterprise and a

financial liability or equity instrument of another.

• FRS 102 distinction:

• ‘Basic’ (Section 11) and ‘Other’ (Section 12).

• Recognition and measurement principles of IAS

39/IFRS 9 can be used instead.

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42

Financial instruments – scoping issues

Investments in subs,

assocs, JVs Rent arears

Accrued revenue

Leases

Cash Trade

creditors Accruals Bank loans

Service charge arrears

Interest rate swaps

Onerous lease

provisions

Warranty obligations

Financial guarantees

DB pension schemes

Investment in shares

Intercompany balances

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Measurement

INITIAL

MEASUREMENT

SUBSEQUENT

MEASUREMENT

Basic non

financing

Transaction price Transaction price

less impairment

Basic financing Present value of

future payments

discounted at mkt

rate for similar debt

instrument

Amortised cost

less impairment

Other Fair value Fair value

Para 11.9 (revised)

Returns to the holder are:

A fixed amount.

Positive fixed rate or positive variable rate.

Combination of positive or negative fixed rate and positive variable rate.

Contract may provide for repayments to be linked to a single observable index of general price inflation … provided not leveraged.

Contract may provide for determinable variation of return to the holder provided … not contingent on future events other than:

Change of contractual variable rate.

Protect holder against credit deterioration of issuer.

Changes in levies applied by central bank or arising from changes in relevant tax or law.

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Para 11.9 (revised)

There is no contractual provision that could, by its terms, result in the holder losing principal/interest.

Contractual provisions that permit issuer (borrower) to prepay a debt or permit the holder (lender) to put it back before maturity are not contingent on future events other than to protect:

the holder against the credit deterioration of the issuer.

the holder or issuer against changes in levies applied by a central bank or arising from changes in relevant tax or law.

Contractual provisions may permit the extension of the term of the debt instrument, provided the above criteria are met.

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Scenarios

1. Loan with interest based on LIBOR plus 50 basis

points plus option for borrower to convert either to RPI

plus 80 basis points or to fix in exchange for a fee.

2. Fixed rate loan – bank has option to periodically

reprice the fixed rate; if exercised the borrower has the

option to repay without penalty.

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Scenarios

3. £10M floating rate loan with exercised option to fix via

an embedded swap plus a separate option to repay the

underlying loan early with penalty.

4. Loan with differential interest charge linked to the level

of reported surplus.

Derecognition of loan

48

When loan

extinguished

When terms

substantially modified

• >10% shift in cash flows

discounted using the

original rate?

• Assuming obligations

discharged, cancelled or

expired

Scenarios….

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£1M loan paying interest annually at 5% (market

rate) with all capital repaid at the end of 10 years.

New loan agreed at the end of year 5 to increase

interest rate to 7% but capital repaid over 20

years.

Substantial modification?

£1M loan paying interest annually at 5% (market

rate) with all capital repaid at the end of 10 years.

After 5 years borrower exercises option to swap

floating rate for fixed rate.

Substantial modification?

Agreements to pay - example

A tenant has a rental of £100 per week. The tenant is

£1,000 in arrears.

The RP and the tenant agree a schedule of payments

of £2 per week on top of the £100 per week already

due to remedy the arrears over a 500 week period.

What the accounting treatment be:

(1) Under existing GAAP

(2) Under new GAAP?

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Issues

Basic or other?

PV of future payments discounted at market

rate

Financing? Adjust on transition?

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Transition adjustments

52

FRS 102 para 35.9a

For financial assets and liabilities that would have been derecognised under this FRS in a transaction that took

place before the date of transition, but that were not recognised under an entity’s previous accounting

framework, an entity may choose:

(1) to derecognise them on adoption of this FRS; or

(2) to continue to recognise them until disposed of or settled.

Multi-employer pension schemes

53

Paragraph 28.11A Where an entity participates in a defined benefit plan which is a multi-employer plan that in accordance with paragraph 28.11 is accounted for as if it were a defined contribution plan, and it has entered into an agreement with the multi-employer plan that determines how it will fund a deficit, the entity shall recognise a liability for the contributions payable that arise from the agreement (to the extent that they relate to the deficit) and the resulting expense in profit or loss in accordance with paragraphs 28.13 and 28.13A.

Multi-employer pension schemes

Paragraph 28.13A

When contributions to a defined contribution plan (or a defined benefit plan which, in accordance with paragraph 28.11, is accounted for as a defined contribution plan) are not expected to be settled wholly within 12 months after the end of the accounting period in which the employees render the related service, the liability shall be measured at the present value of the contributions payable using the discount rate specified in paragraph 28.17. The unwinding of the discount shall be recognised as a finance cost in profit or loss in the period it arises.

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Example

• On implementation of FRS 102, an RP has discounted obligations in respect of past service to pay to SHPS of £500K (applying 5% discount rate).

• Payments of £100K and £80K are made in 2015 and 2016 respectively.

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Solution

• Year 1

Dr Opening reserves

Cr Pension liability

Dr Interest payable

Dr Pension liability

Cr Cash

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Solution (continued)

• Year 2

Dr Interest payable [(£500K-£75K) x 5%] £ 21,000

Dr Pension liability £ 59,000

Cr Cash £ 80,000

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Solution

2015-16

£000

2016-17

£000

Reserves

Prior year adjustment

I&E

Interest payable

Past service cost

58

• Option to just record amount received and adjust to reflect interest accrued

Loan

(concessionary loan)

• Recognise as deferred income in SOFP

• Reclassify to recycled capital grant liability on redemption

Grant

HomeBuy

59

• Assets transferred at fair value

• No additional value attributed to grant transferred – disclose contingent liability

Stock swaps

• 3rd party prepaid to undertake work; agreement with same 3rd party to undertake work

• No offset of assets/liabilities or income/expenditure allowed

VAT shelters

Other specialist areas

60

Practical challenges

1. Gathering information.

2. Identifying and valuing investment properties.

3. Re-evaluating impairment.

4. Identifying non-basic financial instruments.

5. Identifying and calculating pension commitments.

6. Calculating transitional adjustments re-grant.

7. Considering transitional exemptions.

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Not allowed Optional

(Main provisions)

Derecognition of financial assets &

liabilities

Business combinations

Hedge accounting Share-based payment transactions

Accounting estimates Fair value or revaluation as deemed

cost of fixed asset

Discontinued operations Dormant companies

Measuring non-controlling interests Lease incentives

Impracticability – catch all

Exceptions and exemptions to retrospective

application

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FRS 102 para 35.9c

Fair value as deemed cost

‘A first time adopter may elect to measure…an item of

property, plant and equipment…on the date of transition to this

FRS at its fair value and use that fair value as its deemed cost

at that date’

Transition adjustments

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Processes, systems & people

Processes

• Policies & procedures

• Controls

• Valuations

• Management reporting

• Budgeting

Systems

• New accounting systems – including training?

• Data gaps

• Updated chart of accounts

• New procedures

People

• Training and knowledge embedding

• Project management

• Resources and skills to manage change

• Corporate governance

• Communication with stakeholders

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65

The auditor’s perspective

Getting to grips with the

new rules

Providing you with the help

you need

Ethical considerations

Materiality

66

The auditor’s perspective

Misstatement risks

Transition adjustments –

impact on three balance sheets!!

‘Undue cost and effort’

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Objective

• Update you on imminent changes to UK GAAP in FRS 102 and the

related SORP and what steps RPs should take to prepare for their

implementation.

Getting Ready for the new GAAP

www.insight-training.biz

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SOLUTIONS

69

Transfer from I&E reserve

to revaluation reserve?

£4.25M

70

71

Carrying amount of 3 bed development

£000

Land cost 50

Building cost 1,200

Less depreciation (48)

Less amortised grant (96)

Carrying amount 1,106

72

Recoverable amount of 3 bed development

Fair value less costs to sell (£000)

Total 500

Depreciated replacement cost (£000)

Total land 50

Total buildings 900

Less depreciation (36)

Total 914

Double entry?

Dr Operating costs £192K

Cr PPE £192K

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Solution

Old SORP

£

New SORP

£

I&E:

Depreciation 2,200 dr 3,200 dr

Grant income - -

Grant amortisation - 1,500 cr

Net impact (Dr/(Cr)) 2,200 dr 1,700 dr

75

Financial instruments -scope

Investment s in subs,

assocs, JVs Rent arears

Accrued revenue

Leases

Cash Trade

creditors Accruals Bank loans

Service charge arrears

Interest rate swaps

Onerous lease

provisions

Warranty obligations

Financial guarantees

DB pension schemes

Investment in shares

Intercompany balances

Multi-employer pension scheme

• Year 1

Dr Opening reserves £500,000

Cr Pension liability £ 500,000

Dr Interest payable (£500K x 5%) £ 25,000

Dr Pension liability £ 75,000

Cr Cash £ 100,000

76

Multi-employer pension scheme

2015-16

£000

2016-17

£000

Reserves

Prior year adjustment 500 -

I&E

Interest payable

25 21

Past service cost

- -

25 21

77