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The purpose of this overview paper is to assist companies and other businesses who are thinking of choosing or have already chosen to apply Financial Reporting Standard (FRS) 105. In particular, it provides an overview of the key accounting changes and the key tax considerations that arise for those companies and other businesses that transition from the Financial Reporting Standard for Smaller Entities (FRSSE) and Old UK generally accepted accounting practice (GAAP) to FRS 105.
The main section of this paper is split into 2 parts:
part A of this paper compares the accounting and tax differences that arise between Old UK GAAP, the FRSSE and FRS 105 (note that the FRSSE will in most cases require the same accounting treatment as Old UK GAAP – any difference will be highlighted in the relevant section of this paper)
part B of this paper provides a summary of the key accounting and tax considerations that arise on transition from Old UK GAAP or the FRSSE to FRS 105
Although FRS 105 states that it’s only applicable to companies, qualifying partnerships (as defined in Partnerships (Accounts) Regulations 2008) and limited liability partnerships who choose to apply the micro-entities regime, HM Revenue and Customs (HMRC) will generally accept calculations of profit for unincorporated businesses prepared under FRS 105 if they meet the size criteria to apply FRS 105 (see A3.3 and A3.4 in Appendix III of FRS 105.
This overview paper is therefore aimed at both companies that are within the charge to Corporation Tax and individuals (and other entities) within the charge to Income Tax.
There are certain significant differences between the tax treatment of items for Corporation Tax and Income Tax purposes. For example there are specific rules for loan relationships, derivative contracts and intangible fixed assets which only apply for the purposes of Corporation Tax, and this overview covers the main differences.
HMRC has prepared separate papers for companies that transition from Old UK GAAP to FRS 101 or FRS 102, and a paper for individuals and other businesses that transition from Old UK GAAP to FRS 102.
This paper reflects HMRC’s current thinking and it’s based on the law as it stands as at the date of publication. It’s intended it will be updated as more information is available and as new accounting standards and tax law develop.
The information given in this overview is of a general nature. Businesses shouldn’t rely on this information in isolation and it’s not intended as a substitute for referring to the accounting standards and tax law. Changing the basis on which accounts are prepared is a complex area and entities may wish to consider discussing the implications of transition with their advisers or consult the detailed guidance in the HMRC manuals.
It remains the responsibility of the business to ensure that it prepares accounts (or, for un-incorporated business, calculates its profit) in accordance with relevant GAAP and submits a self-assessment in line with UK tax law. Note that where HMRC considers that there’s, or may have been, avoidance of tax the analysis as presented will not necessarily apply.
Summary of the changes to the accounting standards
There currently exists a suite of accounting standards in the UK. Subject to certain restrictions detailed in the respective standards themselves, businesses may choose or may be required to prepare their accounts under one of the following:
- EU endorsed International Financial Reporting Standards (IFRS) and IAS - those accounts prepared in accordance with International Accounting Standards within the meaning of section 395 of the Companies Act
- New UK GAAP - FRS 100, FRS 101, FRS 102 and FRS 105. Entities applying New UK GAAP will, within the framework of FRS 100, apply one of the following
- FRS 101 is effectively the recognition and measurement requirements of IAS subject to some adjustments to ensure alignment with UK Companies Act and also reduced disclosure requirements
- FRS 102 is a new suite of accounting requirements which are closely aligned to, but are not the same as, IFRS
- section 1A of FRS 102, available to small entities, is aligned to FRS 102 but with reduced disclosures and presentation requirements
- FRS 105 is based on the recognition and measurement requirements of FRS 102, with some accounting simplifications and reduced disclosures for eligible micro entities
- Old UK GAAP - substantively the FRS’s, statement of standard accounting practice’s (SSAP), Urgent Issues Task force’s (UITF) and relevant accepted practice in existence and applied prior to the introduction of New UK GAAP - for purposes of this paper this is described as ‘Old UK GAAP’ - for the avoidance of doubt this paper includes FRS 26 (and related standards) within its meaning of Old UK GAAP unless otherwise stated
- Financial Reporting Standard for Smaller Entities (FRSSE) - businesses that meet the eligibility criteria may prepare and file abbreviated accounts
- Micro entities - businesses required to file accounts that meet the eligibility criteria, may prepare and file abridged accounts - with effect for periods commencing on or after 1 January 2016 these requirements are contained in FRS 105
For periods commencing on or after 1 January 2015 UK medium and large businesses won’t be permitted to prepare their accounts in accordance with Old UK GAAP. Instead such entities which applied Old UK GAAP will need to transition from Old UK GAAP to one of the alternatives. It’s expected that for many companies currently applying Old UK GAAP they’ll transition to one of FRS 101 or FRS 102.
For periods commencing on or after 1 January 2016 small businesses won’t be permitted to prepare their accounts in accordance with the FRSSE. Instead such companies will need to transition to one of the New UK GAAP alternatives. It’s expected that for many entities currently applying FRSSE they’ll transition to FRS 105, or section 1A of FRS 102.
Transition to New UK GAAP will impact on the accounts in 2 key ways:
- assets and liabilities at the accounting transition date will be identified, recognised and measured in line with the requirements of the new standard
- thereafter profits and losses will be recognised in accordance with the new standards. These may differ from those profits and losses that would have been reported had Old UK GAAP or the FRSSE been retained
Interaction of these changes with tax
Tax legislation for businesses requires that the profits of a trade are calculated in accordance with generally accepted accountancy practice, subject to any adjustment required or authorised by law in calculating profits for corporation tax (section 46 Corporation Tax Act (CTA) 2009) or income tax (section 25 of Income Tax (Trading and Other Income Act 2005 (ITTOIA)) purposes. Similar rules exist in other parts of the tax legislation.
Generally accepted accountancy practice for corporation tax purposes is defined at section 1127 CTA 2010 and is:
- UK GAAP – generally accepted accountancy practice in relation to accounts of UK companies (other than IAS accounts) that are intended to give a true and fair view or
- in relation to a company that prepares IAS accounts means generally accepted accountancy practice in relation to IAS accounts
Company accounts prepared in accordance with FRS 105 are presumed in law to give a true and fair view.
Non-UK incorporated companies
It’s possible for companies incorporated outside of the UK to be resident in the UK. In addition, the tax statute can require consideration of the application of generally accepted accounting practice to companies that aren’t resident in the UK (for example, Controlled Foreign Companies).
In most cases the same statutory definition of generally accepted accounting practice applies. As such, where the company prepares IAS accounts, these will be used to calculate profits and in other cases the profits will be calculated on the basis of UK GAAP (as it would be applicable for such a company).
Part A – comparison between Old UK GAAP and FRS 105
This section compares the ongoing accounting and tax differences that arise between Old UK GAAP and the FRSSE, and FRS 105.
1. Reporting financial performance
Old UK GAAP and the FRSSE
Accounts prepared in accordance with Old UK GAAP and the FRSSE are required to present, amongst other things, a profit and loss account (P&L), balance sheet and where applicable a statement of total recognised gains and losses (STRGL). The format of the P&L and balance sheet are determined by company law, whilst the format of the STRGL is set by FRS 3. The text of the FRSSE includes the company law P&L and balance sheet formats, and the STRGL requirement.
Accounts prepared under FRS 105 are also required to present a balance sheet (or ‘statement of financial position’). Section 5 of FRS 105 requires the profit or loss for the period to be presented in an income statement. There’s no requirement in FRS105 for a STRGL or any similar statement.
In many cases the terminology used in FRS 105 differs from Old UK GAAP. As a result, it’s possible that certain items will be described differently compared with previously and from one entity to another. FRS 105 does permit the use of titles or descriptions that differ to those used in the standard itself, and some companies may retain the Old UK GAAP or FRSSE descriptions.
The following table sets out the statements which are broadly equivalent.
|Old UK GAAP||FRS 105|
|Profit and loss account||Income statement|
|Balance sheet||Statement of financial position|
Appendix II of FRS 105 provides a comparison table of Companies Act terminology and FRS 105 terminology.
While the references and titles used in FRS 105 are aligned to those used in IAS the tax statute has been updated to cover both sets of terminology. A reference in statute to the income statement, for example, will take its normal accounting meaning.
2. Consolidated accounts or separate financial statements, investments in associates and joint ventures
Whether prepared using Old UK GAAP (or the FRSSE) or New UK GAAP the relevance of consolidated accounts and equity accounting is very limited in UK tax law.
An entity can’t apply FRS 105 if it’s required to or chooses to present consolidated financial statements (because it’s excluded from the micro-entities regime).
The FRS 102 overview papers show the consolidated accounts requirements for FRS 102 entities.
Typically, things like the accounting treatment of associates, joint ventures in individual financial statements has no relevance for tax under current UK law.
3. Accounting policies, estimates and errors
Accounting for a change in accounting policy
FRS 3, Reporting financial performance, requires that changes in accounting policy are applied retrospectively and that the cumulative effect of prior period adjustments (PPA) are presented at the foot of the STRGL. The FRSSE also requires this treatment.
Section 8 of FRS 105 requires that a change in accounting policy resulting from a change in its requirements, is accounted for in accordance with any transitional provisions it sets out. All other accounting policy changes (that is, those that don’t result from changes to FRS 105 itself) are accounted for retrospectively, to the earliest period practicable.
The requirement to apply the policy retrospectively is similar between Old UK GAAP, the FRSSE and FRS 105, but there’s a difference in how this is presented. As noted above, under Old UK GAAP, FRS 3 and the FRSSE require that the cumulative effects of PPAs are presented at the foot of the STRGL. In contrast FRS 105 requires that an adjustment is made to the opening balance of each affected component of equity (corresponding to the changes in the opening balances of assets and liabilities).
Accounting for change in estimate
Old UK GAAP and the FRSSE require that a change in estimate is applied prospectively. For example, where an entity changes the useful estimated life of a tangible fixed asset it doesn’t adjust the depreciation brought forward. Instead the depreciation is adjusted prospectively to reflect the revised useful economic life.
FRS 105 is consistent with Old UK GAAP in this regard.
Accounting for errors
Where a fundamental error is identified, FRS 3 and the FRSSE require that this is accounted for by restating the prior period comparative figures. Errors that aren’t considered fundamental are accounted for in the period they are identified.
Section 8 of FRS 105 requires that, to the extent practical, a business shall correct material errors retrospectively in the first financial statements authorised for issue after the error is discovered. This is achieved through restating the prior period comparative figures. Errors that aren’t considered to represent material errors are accounted for in the period they are identified.
For trading profit Chapter 14 Part 3 CTA 2009 (for Corporation Tax) and Chapter 17 Part 2 ITTOIA (for Income Tax) provides that where there’s a change from one valid basis on which the profits of a trade are calculated to another valid basis (for example on a change of accounting policy), an adjustment must be calculated to ensure that business receipts will be taxed only once and deductions will be given once and once only – see part B, section 20 of this paper.
That approach will continue to apply for PPAs arising in accordance with section 8 of FRS 105.
For property businesses, Chapter 5 Part 4 CTA 2009 (for Corporation Tax) and Chapter 7 Part 3 ITTOIA (for Income Tax) deal with adjustments required where the basis on which the profits are calculated changes.
For companies within the charge to corporation tax, similar tax rules apply for changes in accounting policies or errors on non-trade items, such as loan relationships, derivative contracts and intangible fixed assets – see part B, sections 22 and 23 of this paper.
The above applies to changes from one valid basis to another. Where the change is from an invalid basis (such as may occur when a material error is identified in the accounts), UK tax law requires the invalid basis to be corrected for tax purposes in the period it first occurred with subsequent periods also corrected for tax purposes. Whether tax can be collected or repayments claimed for earlier periods is dependent on the time limits for making or amending self-assessments.
4. Financial instruments
In accounting terms, a financial instrument is a contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another. Examples of common financial instruments include
- trade debtors
- trade creditors
- debt instruments
Businesses applying Old UK GAAP fall into 2 main camps – those applying FRS 26 and those that do not. The FRSSE financial instrument requirements are the same as Old UK GAAP without FRS 26 (that is, FRSSE businesses haven’t adopted FRS 26). References below to Old UK GAAP businesses that haven’t adopted FRS 26 should be taken as referring also to FRSSE businesses.
Businesses that haven’t adopted FRS 26 are likely to see few changes as a result of adopting FRS 105. FRS 105 doesn’t allow fair value accounting, and so financial instruments are accounted for under a cost model. There’s no accounting policy choice under FRS 105 for financial instruments.
This overview doesn’t cover the cases where FRS 26 has been adopted.
For accounting periods commencing on or after 1 January 2016 there are changes to the loan relationship and derivative contract rules which may affect the tax treatment, including new rules that apply from 1 April 2016. In particular, the tax treatment now typically follows the amounts recognised in profit or loss.
4.2 General requirements
Old UK GAAP
For businesses not applying FRS 26 there’s no specific, comprehensive standard for financial instruments in Old UK GAAP. Instead, accounting for financial instruments is primarily determined by the requirements of FRS 4 (issuer of capital instruments), SSAP 20 (foreign currency transactions), FRS 5 (substance over form, including some recognition or derecognition issues). For businesses applying the FRSSE, borrowings are accounted for under a cost model.
For businesses not applying FRS 26, the accounting for financial instruments mentioned above follows the general principles in FRS 18, particularly the accruals concept, and relevant provisions of company law. The Companies Act provides that current assets (such as cash and trade debtors) are recognised at purchase price or cost while the accruals concept is applied in determining, for example, the recognition and measurement of interest income in lenders.
FRS 105 section 9 provides a business with specific guidance on accounting for all financial instruments. There are certain exceptions to what is covered by section 9, including leases and employers’ rights and obligations under employee benefit plans.
In FRS 105, financial instruments are typically recognised at transaction price and measured on an amortised cost basis. This is largely consistent with Old UK GAAP and the FRSSE.
Tax treatment - Corporation Tax
For companies within the charge to Corporation Tax, most financial instruments will fall to be loan relationships (under Part 5 CTA 2009), non-lending money debts (treated as loan relationships under Chapter 2 of Part 6 CTA 2009) or derivative contracts (under Part 7 CTA 2009). UK tax law provides in general that the accounting treatment of these types of instruments is followed for tax purposes. This paper doesn’t cover those financial instruments that fall outside of these categories – for example, equity instruments in the form of shares and guarantees.
There’s no equivalent legislation for businesses within the charge to Income Tax. This may lead to significant differences from Corporation Tax in tax treatment. In particular, items which are capital in nature will generally not be taken into account for Income Tax purposes.
Tax treatment - Income Tax
Section 25 of ITTOIA requires that the profits of the trade are calculated in accordance with GAAP and these are then adjusted as authorised or required by tax law.
This means that only profit and loss account entries will be considered in the calculation of the profits of the trade calculated in accordance with GAAP.
The next step to consider is whether there’s any adjustment authorised or required by tax law. For example items that are capital in nature will be adjusted for in the tax computation (section 33 ITTOIA) and expenses have to be incurred wholly and exclusively for the purposes of the trade (section 34 ITTOIA).
Tax legislation at section 29 ITTOIA says that, for calculating the profits of a trade, interest is always a revenue (as opposed to capital) item.
Section 58 allows incidental costs of finance by means of a loan or the issue of loan stock to be allowable deductions in calculating the profits of a trade. Sums paid because of losses resulting from movements in the rate of exchange between different currencies and sums paid for protection against such losses are not incidental costs of obtaining finance. (Section 14 (Borrowing costs) also considers section 58).
The distinction between capital and revenue items is an important one for Financial Instruments as this will to a large extent determine the tax treatment. What constitutes a capital item isn’t defined by statute and there’s no single test that will determine the issue in all circumstances. BIM35000 onwards has more guidance about the principles and criteria which need to be considered.
The following are indicators of whether borrowing is of a capital or revenue nature.
Capital borrowing will normally be:
- not temporary
- fixed in amount
- available for use in any of the trader’s activities and not merely the day-to-day trading operations
An example of capital borrowing would be a long term loan of fixed amount which is used to enlarge the capital employed in the trade.
Revenue borrowing will be:
- incurred as an incident of carrying on the day-to-day activities of the business
An example of revenue borrowing would be a bank overdraft facility.
Tax treatment - transitional adjustments
For many companies that are thinking of or have moved to FRS 105, it’s expected that their accounting for financial instruments under FRS 105 will be the same as under old UK GAAP and the FRSSE. Where, however, a financial instrument is measured on a different basis under FRS 105 compared with Old UK GAAP or the FRSSE it’s likely that transitional adjustments on adoption of FRS 105 will arise. For further guidance on the transitional provisions applying to financial instruments see part B of this paper.
Further detail on specific transactions involving financial instruments where the requirements of FRS 105 differ from the requirements of Old UK GAAP or the FRSSE are set out below.
4.3 Debt-equity swap
Where debt is extinguished through the issue of an entity’s own equity, the accounting applied in accordance with Old UK GAAP or the FRSSE may differ from that required by FRS 105.
Old UK GAAP, where FRS 26 has not been adopted, permits an accounting policy choice as regards the recognition of a gain or loss. In certain situations it may be appropriate to adopt a no gain or loss policy, so that the value of the equity issued is treated as being equal to the carrying value of the debt given up. However, companies are permitted to adopt a policy of recognising a gain or loss on such transactions. Under both approaches, it’s necessary to consider the interaction with the requirements of company law as regards the amount of share premium to be recorded and the requirements as regards realised profits. The appendix to UITF Abstract 47 explains these points.
FRS 105 doesn’t provide specific guidance on debt-equity swaps. Section 9 of FRS 105 requires that any gain or loss on the derecognition of a financial liability is recognised in profit or loss. In addition section 17 requires that equity instruments are recognised on issue at the fair value of the cash or other resources received. However, companies will need to consider the specific facts and nature of the transaction undertaken. For example, company law considerations regarding realised profits and share premium accounts will need to be considered and may impact on the accounting treatment.
For Corporation Tax, under general principles of the loan relationship regime, an amount of profit recognised to the profit and loss account would be brought into account. However, section 322 CTA 2009 will typically exempt gains arising where a debt is released in consideration of ordinary shares. The Corporate Finance Manual, CFM33200 onwards, has more details about this exemption.
4.4 Debt restructuring or derecognition
Debt may be restructured or have its terms modified such that, in accordance with FRS 5 and Old UK GAAP (where FRS 26 is not adopted) and the FRSSE, no gain or loss would be recognised in the accounts.
FRS 105 doesn’t specifically deal with modification of terms. It says simply that a gain or loss on derecognising a financial liability should be recognised in profit or loss, and that a financial liability is derecognised when the obligation in the contract is discharged, cancelled or expires.
For Corporation Tax, the loan relationship would normally be taxed in line with the amount recognised in the accounts. As such, the profit or loss on derecognition or re-recognition will typically be brought into account.
The government has included within Finance (No 2) Act 2015 an exemption to cover distressed debt, which applies in certain cases where the loan is modified or replaced. This exclusion applies to modifications and releases from 1 January 2015.
For Income Tax, whether or not the gain or loss arising is taken into account for tax purposes will depend on whether the gain or loss relates to borrowing of a capital nature or borrowing of a revenue nature.
On transition section 28 of FRS 105 provides that financial assets and liabilities derecognised under the previous accounting framework shall not be recognised on adoption of FRS 105. Section 28 also provides that where a financial asset or liability would have been derecognised under FRS 105 but under the company’s previous accounting framework hadn’t been derecognised, a company may, on transition, either derecognise the financial asset or liability on adoption of FRS 105 or continue to recognise until disposed of or settled.
However, no exclusions apply where the derecognition occurs after the accounting transition date – that is after the start of the prior period comparatives. As a result, the company may be required to derecognise or recognise the debt.
For Corporation Tax, the Change of Accounting Practice Regulations (COAP) were amended in December 2014 to address this issue in certain instances of distressed debt. For more guidance on the transitional provisions applying to financial instruments see part B of this paper.
4.5 Initial recognition – non-market instruments
Old UK GAAP (where FRS 26 isn’t applied) and the FRSSE, typically require that financial instruments are initially recognised at cost. This cost may or may not equate to the fair value of the financial instrument.
Typically under FRS 105, financial instruments are measured on initial recognition at cost, which is the transaction price.
However where a business purchases inventory, property, plant and equipment, investment property or sells goods and services with settlement deferred beyond normal credit terms, the transaction price is the cash price available on the date of the transaction. The difference between the initial transaction price and the subsequent contractual receipts or payments (excluding transaction costs) is interest income or expense which shall be allocated on a straight line basis over the term of the contract.
For Corporation Tax, the loan relationship would normally be taxed in line with the accounts.
For Income Tax, whether or not an amount debited or credited to the income statement (or, if an income statement isn’t prepared by the business, included in the profit calculation) will be taken into account for tax, will depend on whether the debit or credit relates to a revenue item or a capital item.
More information on whether an item is of a capital or revenue nature can be found under ’tax treatment’ at section 4.2 of this paper.
Potentially this could result in a transitional adjustment. Part B of this paper has more guidance on the transitional provisions applying to financial instruments.
4.6 Hedging relationships or synthetic instruments
Old GAAP (including the FRSSE), where FRS 26 has not been adopted, requires derivatives that are entered into as part of a business’s hedging strategy to be accounted for on an historical cost basis equivalent to that used for the underlying asset, liability, position or cash flow.
FRS 105 requires a different treatment for derivatives. FRS 105 section 9 requires derivatives to be accounted for by spreading their initial cost (transaction price) plus any transaction costs that were not immediately recognised in profit or loss, less any impairment losses incurred to date, over the term of the contract on a straight line basis (or a more appropriate systematic basis). Amounts payable or receivable under the derivative contract are accounted for as they accrue.
For Corporation Tax the loan relationship would normally be taxed in line with the accounts.
In cases where derivatives are measured at fair value there are special rules that would apply (contained within the Disregard Regulations). These rules for hedge accounting will not typically be applicable for companies within the charge to Corporation Tax that are applying FRS 105, as fair value accounting is not permitted under this accounting standard.
For Income Tax the principles outlined at section 4.2) above will need to be considered.
Potentially this could result in a transitional adjustment. Part B has more information about the transitional provisions applying to financial instruments.
4.7 Hybrid instruments or embedded derivatives
This paper doesn’t address in detail the position of hybrid instruments or embedded derivatives. This is a complex area and affected companies will need to consider the accounting and tax treatment carefully.
In overview, FRS 26 requires companies to separate out (‘bifurcate’) embedded derivatives from host contracts. However, bifurcation is not typically permitted under Old UK GAAP (where FRS 26 is not applied) or under section 9 of FRS 105 (although the issuer of compound instruments will still separate out the equity component in accordance with FRS 25 or FRS 105 section 17 respectively). Links to the relevant guidance are set out in section 18 of this paper.
5. Inventories or stock
Section 10 of FRS 105 differs from SSAP 9 (and the FRSSE) insofar as it specifically excludes from its scope work in progress in the course of construction contracts (covered in section 18 of FRS 105) and agricultural produce and biological assets (covered in section 27 of FRS 105).
For many businesses these differences will have no impact on the recognition or measurement of stock.
Businesses operating in the agriculture sector will, in accordance with FRS 105, measure biological assets at cost less accumulated depreciation. Agricultural produce harvested from biological assets are measured at the point of harvest at the lower of cost, and estimated selling price less costs to complete and sell.
Typically stock is measured for accounting purposes at the lower of cost and net realisable value and this is followed for tax purposes.
There are particular tax rules, the herd basis, that can be applied to particular farm animals. BIM55000 has more information about this and the valuation of farming stock.
6. Investment property
Old UK GAAP (SSAP 19) requires a business to carry investment properties at their open market value with movements in value recognised each period in the statement of recognised gains and losses (STRGL) unless they represent a permanent diminution in value, in which case they are recognised in the P&L. Where investment properties are let to and occupied by another group entity for its own purpose, SSAP 19 contains an exemption which excludes such properties from its scope (they would instead be included as part of tangible fixed assets). The FRSSE has the same requirements as SSAP19.
FRS 105 requires that investment property is initially recognised at cost (or if settlement is deferred beyond normal credit terms, the transaction price is the cash price available on the recognition date) and subsequently measured at cost less accumulated depreciation. However in contrast to SSAP 19 and the FRSSE, FRS 105 section 12 doesn’t contain an exemption for property let to and occupied by group entities. Hence certain properties treated as tangible fixed assets under Old UK GAAP may now be classified as investment property assets under section 12 of FRS 105.
The accounting treatment of investment properties doesn’t determine, for tax purposes, whether the property is held as a property held for investment (giving a capital receipt on disposal) or whether it’s part of a trading transaction (and so is on revenue account and forms part of the company’s trading profits).
Assuming the property is held, for tax purposes, as an investment, the income arising on the property is brought into tax as it’s recognised in the accounts (for example, rental income would be bought into tax as recognised in profit or loss). The disposal of properties held for investment will typically give rise to a chargeable gain.
7. Property, plant and equipment
Section 12 of FRS 105, and FRS 15, concern property, plant and equipment (PPE) or tangible fixed assets to use the Companies Act and FRS 15 terminology. Both standards are broadly consistent in principle (and the FRSSE is consistent with FRS 15). However differences are present, in particular section 12 of FRS 105:
- requires that major spare parts are included in PPE
- requires that cost is measured by reference to the cash price available at the recognition date, where payment is deferred beyond normal credit terms
- doesn’t permit the use of renewals accounting
- requires that residual values are based on current prices rather than historical prices
UK tax law departs from the accounting standards by disallowing depreciation and revaluations in respect of capital assets, and instead granting capital allowances (on some assets). Hence accounting changes are not expected to have a significant tax impact.
In some cases where revenue expenditure is added to the cost of an asset, tax law follows the accounts by recognising for tax purposes amounts reflected in profit and loss account to the extent that they are a write off of revenue expenditure. In those cases where depreciation under section 12 of FRS 105 differs from that under FRS 15 and the FRSSE (for example, because of revaluation of residual values) tax will follow the amount as per section 12 of FRS 105.
As noted above there’s no equivalent to renewals accounting (FRS 15 paragraph 97 to 99) under section 12 of FRS 105 so there may be an adjustment for tax purposes made under the change of basis legislation – see part B of this paper.
8. Intangible assets including goodwill
Intangible assets, and goodwill arising on business combinations
The definition of an intangible asset in Old UK GAAP (FRS 10) and the FRSSE states that intangible assets are “Non-financial fixed assets that do not have physical substance but are identifiable and are controlled by the entity through custody or legal rights.’’
FRS 105 defines an intangible asset (other than goodwill) as an “identifiable non-monetary asset without physical substance’’ where “identifiable’’ is an asset that is separable or arises from a legal contract or other legal right. This definition is different from that present in Old UK GAAP and FRSSE, in so far as the intangible asset that arises from a legal contract or other legal right need not be separable from the business. FRS 105 allows only intangible assets that are acquired separately (that is, other than in a business combination) to be recognised. FRS 105 section 14 doesn’t allow any intangible assets arising from a business combination to be recognised - only goodwill is recognised, if appropriate.
For Corporation Tax purposes sections 871 to 879 of Part 8 CTA 2009 provide a comprehensive set of rules for changes in accounting for intangibles.
For Income Tax purposes there’s no equivalent to sections 871 to 879 of Part 8 CTA 2009. Instead tax law will determine whether any adjustment is required to the calculation of the trade or property business profit calculated in accordance with GAAP, in particular the capital revenue divide.
Intangible assets and goodwill - Useful Economic Life (UEL)
FRS 10 states that goodwill and intangibles should be amortised over their UEL. It also states that there’s a rebuttable presumption that the UEL won’t exceed 20 years. FRS 10 does permit the use of an indefinite UEL in which case it’s not amortised but is instead subject to annual impairment reviews. The FRSSE doesn’t permit the use of an indefinite useful life, and contains a presumption of a maximum 20 year life.
FRS 105 differs from Old UK GAAP in respect of UEL. Firstly FRS 105 doesn’t permit an indefinite life. All intangibles and goodwill are presumed to have a finite life and the period over which they are subject to amortisation should reflect this. Where the useful life of the intangible asset can be reliably estimated, this life is used as the UEL. Where a reliable estimate of the UEL cannot be made, FRS 105 states that the UEL must not exceed 10 years (the FRSSE maximum was 20 years).
In general relief for Corporation Tax purposes is provided on either the amortisation or impairment of goodwill and intangibles recognised in the accounts. Sections 871 to 873 of CTA 2009 ensure that any write up on the transition from Old UK GAAP or FRSSE to FRS 105 will be a taxable credit for Part 8, and section 872 ensures that any such credit is limited to the net amount of relief already given. Any impairment from written up cost will be deductible.
Tax relief is unlikely to be affected if an entity has elected for a fixed rate of 4%. A fixed rate election must be made within 2 years of the end of the accounting period in which the expenditure was incurred and cannot be reversed.
Also the tax rules changed in 2015. Any goodwill from a business combination that happened after 7 July 2015 is not eligible for tax deductions (that is, amortisation or impairment of such goodwill isn’t allowable as a Corporation Tax deduction). So the 4% fixed rate deduction is similarly not available.
For Income Tax purposes there’s no equivalent to sections 871 to 879 of Part 8 CTA 2009. The amortisation of a capital item wouldn’t be an allowable deduction for Income Tax purposes.
Software costs and research and development
FRS 10 requires that software costs which are directly attributable to bringing an item of IT into use within the business are recognised as part of tangible fixed assets. Where such costs did not relate to bringing an item of IT into use they would typically have been written off direct to the P&L. In addition UITF 29 provides that, where certain criteria are met, website development costs are recognised as part of tangible fixed assets. The FRSSE doesn’t specify how software costs should be treated.
FRS 105 also doesn’t specify how such costs should be treated. Hence the nature of the item should be considered in determining its treatment. It’s possible that having considered the nature of the software that it’s recognised as an intangible asset. But note that if it was internal costs, for example the cost of the company’s own staff in developing software, then those costs must be expensed immediately under FRS 105. This applies to all internally generated intangibles, including research and development.
Old UK GAAP and the FRSSE allow development costs to be recognised as intangible assets (to be amortised), as an accounting policy choice, provided certain criteria are met. Research costs have to be expensed immediately under old UK GAAP and the FRSSE.
For Corporation Tax, in companies where costs on expenditure such as software have been previously written off to the profit and loss account and claimed as a deduction in a calculation of trade profit in respect of expenditure on a tangible asset, the following tax consequences would apply, if the software is in a future period accounted for instead as an intangible asset.
First the adjustment in respect of the change of accounting basis will be taxed under Chapter 14 Part 3 CTA 2009. For example, a positive adjustment is brought into account as a taxable receipt.
Second, capitalised expenditure in respect of an intangible asset will be relieved under the rules in Part 8 CTA 2009 as it’s written down in the accounts (subject to the normal exclusions, including the pre-FA 2002 rule).
Guidance on many of these issues is in the Corporate Intangibles Research and Development Manual CIRD12300 which deals with changes in accounting policies for intangible assets within Part 8 CTA 2009).
For Income Tax, as FRS 105 doesn’t specify how such costs should be treated, the nature of the item should be considered in determining its treatment.
BIM35800 onwards has more guidance about computer software expenditure.
Section 87 ITTOIA allows a deduction for certain research and development expenses of a revenue nature to a person carrying on a trade (but not a profession or vocation).
9. Business combinations
Section 14 of FRS 105 says that a micro entity shall apply section 19 of FRS 102 (that section of FRS 102 is broadly comparable with FRS 6 and FRS 7 in Old UK GAAP, and with the FRSSE), but with some exceptions.
- a micro entity shall not separately identify and recognise intangible assets
- a micro entity shall not recognise a deferred tax asset or liability
FRS 6 and FRS 7 of Old UK GAAP are relevant in UK tax law only where the carrying value of an asset or liability acquired in a business combination is relevant for tax purposes, for example for loan relationships. This also applies where a business is applying FRS 105.
The acquisition of a business is a capital expense for tax purposes.
Tax law determines the value of trading stock for the business ceasing and its value for the successor business. For Corporation Tax see Chapter 11 Part 3 CTA 2009, and for Income Tax see Chapter 12 Part 2 ITTOIA. In respect of goodwill on business combinations please see section 8 of this paper.
Entities that apply Old UK GAAP will use SSAP 21, UITF 28 and FRS 5 in determining the accounting treatment of leases. Entities that adopt FRS 105 will apply the recognition and measurement requirements of section 15 (section 15 doesn’t apply to licensing agreements for such items as motion picture films, video recordings, plays, manuscripts, patents and copyrights).
Old UK GAAP, the FRSSE and FRS 105 consider whether a lease transfers substantively the risks and rewards of the leased asset. However it should be noted that SSAP 21 includes a presumption that if the present value of the minimum lease payments is 90% or more of the fair value of the leased asset that it would typically be classified as a finance lease. Section 15 of FRS 105 doesn’t contain this presumption. Instead, a finance lease arises under FRS 105 if “substantially all the risks and rewards incidental to ownership” are transferred to the lessee.
Nevertheless the emphasis on the transfer of risk and rewards is such that in most cases the classification of leases will be consistent between Old UK GAAP or FRSSE and FRS 105. Once the lease has been classified the accounting treatment thereafter is also, generally, comparable. However differences, even where the classification is the same, do exist and the interaction with tax is noted below.
UITF 28 requires that operating lease incentives in the lessee are spread over the period ending on the date from which it’s expected that the prevailing market rent will be payable (if this period is shorter than the lease term, otherwise over the lease term). This is the same as the FRSSE requirement.
Section 15 of FRS 105 requires that lease incentives are spread over the term of the lease on a straight line basis unless another way would better reflect the reality. Consequently there may be differences in respect of the period over which such incentives are recognised.
Since the accounting is followed where the incentive is not capital (for example, a rent free period) the difference may alter the timing of income recognition for tax purposes.
UK tax law is not entirely consistent with SSAP 21 (see Statement of Practice 3 (1991)). But accounts figures are recognised for the purposes of Chapter 2 Part 9 CTA 2010 and Chapter 2 Part 21 CTA 2010 (for Corporation Tax) and Chapter 10A Part 2 ITTOIA (for Income Tax) which deal with leasing and finance leases with return in a capital form.
For lessors, FRS 105 section 15 requires use of the net investment method for finance leases, whilst SSAP 21 requires the net cash investment method. There may be differences in the timing of income recognition under the 2 bases. In some cases these affect the timing of income for tax purposes, for example where Schedule 12 Finance Act (FA) 1997 applies.
Legislation (in sections 228B to 228F Capital Allowances Act 2001, Chapter 2 Part 9 CTA 2010 (Corporation Tax) and Chapter 10A Part 2 ITTOIA (Income Tax)) brings the tax treatment (of both lessors and lessees) of finance leases of plant and machinery into line with the accounting basis in FRS 105 section 15 or SSAP 21 (or FRSSE) as appropriate.
It’s not envisaged that section 53 FA 2011 will apply to entities on transition to section 15 of FRS 105 by virtue of subsection 3 of section 53 FA 2011.
There are no significant differences between section 16 of FRS 105 and FRS 12 (FRSSE has same rules as FRS12). For tax purposes the recognition and measurement of provisions in the accounts forms the basis for the quantum and timing of tax relief (subject to adjustment where the expenditure is capital for tax purposes or otherwise disallowable).
Consequently, for most businesses it’s not expected that FRS 105 will have a significant tax impact in this area.
12. Revenue recognition
In general, reporting of revenue in accounts is followed for tax purposes. There’s no specific standard for revenue recognition in Old UK GAAP. However, Application note G of FRS 5 provides revenue recognition guidance in respect of the sale of goods and services as well as other specific revenue recognition scenarios, SSAP 9 provides guidance in respect of long term contracts and UITF 40 addresses service contracts. The FRSSE is consistent with Old UK GAAP.
The general principles of revenue recognition within FRS 5 Application note G are that revenue is recognised when the seller obtains the right to consideration in exchange for the goods, services, or work performed. The right to consideration typically derives from the performance of its obligations under the terms of the exchange with the customer. FRS 5 application note G requires that, on recognition, revenue is measured at the fair value of the consideration received or receivable.
Revenue recognition under FRS 105 will primarily be determined by section 18 of FRS 105. The recognition criteria within section 18 are broadly aligned with Old UK GAAP (and the FRSSE). But FRS 105 doesn’t require revenue to be measured at fair value. In FRS 105, revenue is measured at the amount receivable, net of trade discounts, prompt settlement discounts and volume rebates. If payment is deferred beyond normal credit terms, the revenue recorded is equal to the cash price available on the transaction date.
In practice though, for many businesses there’ll be no change following adoption of FRS 105. Consequently for many businesses there’ll be no accounting or tax impact.
13. Government grants
SSAP 4 (and the FRSSE) requires that grants are recognised when there’s reasonable assurance that related conditions, if any, will be met. Where reasonable assurance is present grants are then recognised in the accounts based on the relationship between the grant and the related expenditure.
FRS 105 section 19 states that the grant won’t be recognised until the business has reasonable assurance that it will or has complied with the grant conditions and that the grants will be received. It requires that a business adopts the accruals model to determine the subsequent accounting for the grant. Under the accruals model grants relating to revenue are recognised in income on a systematic basis over the periods in which the business recognises the relevant grant costs.
For tax purposes, grants which meet revenue expenditure, such as staff costs, are normally trading receipts for the entity, and this will continue where section 19 of FRS 105 applies.
14. Borrowing costs
FRS 105 section 20 differs to FRS 15 (and the FRSSE) on capitalising borrowing costs – FRS 15 permits such treatment, but FRS 105 doesn’t. FRS 105 section 20 requires all borrowing costs to be expensed to profit or loss as they are incurred.
For Corporation Tax, under the loan relationship rules companies would generally obtain relief for interest related to borrowings when it’s recognised in P&L.
For Income Tax section 29 ITTOIA says that for calculating the profits of a trade, interest is always a revenue (as opposed to capital) item.
Section 58 ITTOIA allows relief for certain incidental costs of obtaining finance which has been incurred wholly and exclusively for the purpose of obtaining the finance, providing security for it or repaying it.
However, the costs of renegotiating the terms and conditions of loans or of getting out of a loan agreement are capital and not allowable for tax.
15. Share based payments
Accounting for share based payments under Old UK GAAP (FRS 20) and FRS 105 (section 21) is different. In FRS 105 section 21, equity settled transactions are not recognised until the shares are issued. Under FRS 20, a transaction is recognised when the goods or services are received, so companies which previously applied that standard to equity settled transactions will see a difference. However, under the FRSSE, equity settled transactions aren’t recognised until the shares are issued, and therefore companies which previously applied that standard won’t see a difference in accounting.
For cash settled transactions, FRS 105 section 21 requires the liability to be measured (when goods or services are received) by following the measurement rules in section 16 (provisions and contingencies). In FRS 20, the liability under a cash settled transaction is measured at fair value. In the FRSSE, the liability is measured at the best estimate of the expenditure required to settle the liability. In practical terms, this should be the same as under FRS 105.
Tax deductions in respect of share based payments are governed by specific legislation in Part 12 CTA 2009 for Corporation Tax.
Section 94A ITTOIA provides for deductions where a company is within the charge to Income Tax.
16. Employee benefits
In respect of accounting for pension schemes section 23 of FRS 105 differs to FRS 17. Under section 23, for both defined benefit and defined contribution pension schemes, the business will record the cost of the benefits to which employees have become entitled as a result of their services in the period, as an expense. Under FRS 17, a business would recognise a net surplus (asset) or deficit (liability) by comparing the fair value of scheme assets with the scheme liabilities, and would recognise (as expenses) current service costs, interest costs and expected returns on assets. The FRSSE requirement is very similar to FRS 17.
Sections 196 and 246 FA 2004, sections 1290 to 1296 CTA 2009 (for Corporation Tax) and sections 38 to 44 ITTOIA (for Income Tax) provide for relief on a contributions paid basis.
Holiday pay accrual
Under Old UK GAAP many businesses didn’t accrue or provide for holiday pay. FRS 105 requires that when an employee has rendered services to a business during a period, any related holiday pay or similar is accrued for.
For tax purposes this accrual would be treated in line with the treatment of unpaid remuneration which is dealt with at Part 20 Chapter 1 CTA 2009 (for Corporation Tax) and sections 36 to 37 ITTOIA (for Income Tax).
Employee benefit trusts
Under Old UK GAAP, UITF 32 provides guidance on how to account for employee benefit trusts. FRSSE businesses would be expected to follow the principles of UITF 32.
The requirements of FRS 105 (section 7) are comparable. FRS 105 states that there’s a rebuttable presumption that contributions to an intermediate payment arrangement where the employer is a sponsoring entity are made in exchange for another asset and do not represent an immediate expense.
In addition the assets and liabilities of the intermediary will be accounted for by the sponsoring entity as an extension of its own business.
The above treatment doesn’t apply where it can be demonstrated that the sponsoring entity will not obtain future economic benefit from the amounts transferred or it doesn’t have control of the right or other access to the future economic benefit.
For tax purposes the treatment of employee benefit contributions is dealt with at Part 20 Chapter 1 CTA 2010 (for Corporation Tax) and sections 38 to44 ITTOIA (for Income Tax). Generally a deduction is deferred until employment taxes are paid on the employee benefits.
17. Foreign currency translation
Under Old UK GAAP a business accounts for its currency exchange transactions in line with either SSAP 20 (where FRS 26 isn’t applied) or FRS 23 (where FRS 26 is applied). For businesses which followed SSAP 20 (or the FRSSE), the transition to FRS 105 section 25 isn’t expected to result in any significant changes (though there may be if the company uses contracted rates or forward currency contracts for trading transactions - see section 17.3).
Most micro entities will not have previously applied FRS 23, but for those that have, they’ll encounter some differences (see section 17.3).
17.2 Foreign branches
If a business has a foreign branch, FRS 105 section 25 says that the business should refer to the requirements of FRS 102 section 30 (Foreign Currency Translation) to determine if that foreign branch has a different functional currency. If it does, the business should apply the requirements of FRS 102 section 30 to its transactions. There could be a significant difference, if the local currency that was determined under SSAP20 (or FRSSE) is different to the functional currency determined under FRS 105.
For tax purposes, the calculation of the business’s profits from a trade or business undertaken through a foreign branch will typically be based on the amounts of profit or loss translated into the business’s functional currency in accordance with GAAP.
17.3 Contract rate accounting
Where a business covers a trading transaction with a forward contract, SSAP 20 states that the exchange rate specified by the forward contract may be used to record the transaction. But in FRS 105 section 25, a business must use the specified contract rate in a forward contract.
A possible difference will arise for companies that previously have adopted FRS 23. FRS 23 doesn’t allow the use of a contracted rate to record the transaction. But under FRS 105, where a company enters into a transaction with a contracted exchange rate, the rate of exchange specified in that contract must be used.
18. Liabilities and equity
Accounts prepared in accordance with Old UK GAAP will apply the presentation and disclosure requirements of FRS 25 in respect of financial instruments and in particular liabilities and equity. The FRSSE follows the same principles as FRS 25, but doesn’t contain explicit requirements about separating the debt and equity components of a compound financial instrument (though FRSSE users would be expected to look to FRS 25 to establish current practice, if they had such financial instruments).
Section 17 in FRS 105 contains comparable (to FRS 25) requirements. Consequently on transition from Old UK GAAP to FRS 105 no changes are expected in respect of the classification or presentation of liabilities and equity that currently fall within the range of FRS 25. If a FRSSE entity with compound financial instruments hadn’t previously separated out the debt and equity components, they would see a change on transition to FRS 105. But there’s an exemption available (FRS 105 section 28.10(d)): if the liability component isn’t outstanding at the date of transition to FRS 105, the instrument doesn’t have to be separated in the first FRS 105 accounts.
Whether a business sees a difference in how items are measured under FRS 105 depends on whether they previously had adopted FRS 26 or not. Businesses that hadn’t adopted FRS 26 (so this includes FRSSE businesses) won’t see any significant change. However, businesses that had adopted FRS 26 will see differences in how FRS 105 will require them to subsequently measure, for example, the debt component of a compound financial instrument.
Guidance on the taxation of hybrid and compound instruments in both issuer and holder is available in the Corporate Finance Manual. In particular, see:
- CFM37600 (Bifurcated instruments under the loan relationship rules)
- CFM50410, CFM50420, CFM50430 and CFM52500 (Bifurcated instruments under the derivative contract rules)
- CFM55200 (Holder of convertible or share-linked securities)
- CFM55400 (Issuer of convertible or share-linked securities)
Part B of this paper has more information about the transitional provisions applying to hybrid instruments.
19. Specialised activities
FRS 105 section 27 includes specific guidance on agricultural activities. This is not addressed within this paper.
Part B - transitional adjustments (Old UK GAAP to FRS 105)
This section gives a summary of the key accounting and tax considerations that arise on transition from Old UK GAAP or the FRSSE to FRS 105.
In accounting terms, transition to FRS 105 is addressed in section 28 of FRS 105.
On transition FRS 105 section 28 requires that the balance sheet presented in respect of the accounting transition date:
- recognises all assets and liabilities whose recognition is required by FRS 105
- doesn’t recognise assets and liabilities if FRS 105 doesn’t permit such recognition
- reclassifies assets, liabilities and components of equity to ensure presentation is consistent with FRS 105
- measures all recognised assets and liabilities in accordance with FRS 105.
The transition date, for accounting purposes, is the first day of the earliest accounting period presented in the accounts. For example for entities preparing their accounts at 31 December 2016 the transition date will be 1 January 2015.
FRS 105 contains transitional exceptions and exemptions to the above requirements. These aren’t not repeated here in detail but cover areas such as business combinations, estimates and investment property.
However, even with such exceptions and exemptions it’s expected that on transition there may be a number of adjustments both to the carrying value of assets and liabilities recognised previously under Old UK GAAP and in terms of newly recognised assets and liabilities. For accounting purposes these adjustments will be made to the assets and liabilities as at the accounting transition date with a corresponding adjustment made directly to the opening P&L reserves.
For trading profit, Chapter 14 Part 3 CTA 2009 (for Corporation Tax) and Chapter 17 Part 2 ITTOIA (for Income Tax) provide that where there’s a change from one valid basis on which the profits of a trade are calculated to another valid basis (for example on a change of accounting policy), an adjustment must be calculated to ensure that business receipts will be taxed once and once only and deductions will be given once and once only.
For property businesses Chapter 5 Part 4 CTA 2009 (for Corporation Tax) and Chapter 7 Part 3 ITTOIA (for Income Tax) deal with adjustments required where the basis on which the profits are calculated changes.
For Corporation Tax purposes, adjustments are treated as receipts or deductions when working out the trade or property business profits.
For Income Tax purposes, a positive adjustment is treated as ‘adjustment income’ and charged to Income Tax and a negative adjustment is treated as an allowable expense (adjustment expense) in working out the profits of the trade or property business.
BIM34130 has details of the calculation.
21. General trading
The relevant legislation for Corporation Tax is in CTA 2009 Chapter 14 Part 3 and for Income Tax is in Chapter 17 Part 2 ITTOIA. Section 180(4) CTA 09 and section 227(4) ITTOIA explains:
A “change of accounting policy” includes, in particular both -
(a) a change from using UK generally accepted accounting practice to using generally accepted accounting practice with respect to accounts prepared in accordance with international accounting standards.
(b) a change from using generally accepted accounting practice with respect to accounts prepared in accordance with international accounting standards to using UK generally accepted accounting practice.
So while it details UK GAAP to IAS and vice versa, the key phrase is that a ‘change of accounting policy includes in particular’ those 2 cases. While the change from Old UK GAAP or the FRSSE to FRS 105 isn’t listed, it’s still included within the range of this provision.
The relevant legislation is in CTA 2009 at Part 8, Chapter 15. (These provisions apply only to companies within the charge to Corporation Tax)
Where there’s a change of accounting policy in drawing up a company’s accounts from one period of account to the next, and both those accounts are drawn up in accordance with GAAP in relation to those periods then the provisions of Chapter 15 will apply.
No taxable credit or allowable debit is to be brought into account under Chapter 15 to the extent that it’s already brought into account by section 723 (revaluations), section 725 (reversal of accounting loss) or section 732 (reversal of accounting gain). See section 878 CTA 2009.
Change in accounting value
When there’s a change of accounting policy it’s possible that there’ll be a difference between the accounting values recognised at the end of the earlier period and the opening balance in the later period for certain intangible fixed assets. Where such a difference arises and no section 730 election has been made, section 872 treats an increase as a taxable credit and a decrease as an allowable debit arising at the start of the later accounting period.
The amount of the debit or credit is the difference multiplied by the fraction tax written down value or accounting value where both these values are those at the end of the earlier period. Section 872(5) caps the amount of any credit to the net amount of previous debits on the asset less previous credits on the asset.
Chapter 15 also contains different rules to deal with a change of policy involving disaggregation or where the asset is subject to a fixed-rate writing down election under section 730.
Primacy of other parts of Part 8
Section 878 contains provisions to ensure that where all or part of the difference is brought into account under other sections of Part 8 that part isn’t brought into account again. The relevant sections are section 723 (gain on revaluation, CIRD13050), section 725 (reversal of accounting loss CIRD13090) and section 732 (reversal of accounting gain CIRD12560).
Section 872 doesn’t apply to a chargeable intangible asset in respect of which a fixed rate election has been made under section 720 (see CIRD12905).
These provisions apply only to companies within the charge to Corporation Tax.
23. Financial instruments
Transitional adjustments – general information
Adjustments on loan relationships as a result of changes in accounting policy can arise under 2 separate parts of the regime.
Prior period adjustments
In cases where a company stays within the same accounting framework, or otherwise doesn’t restate its opening figures, the accounts will normally show a prior period adjustment (PPA) either in reserves or in equity. For loan relationships section 308 ensures that this amount is brought into account for tax purposes where it’s taken to the statement of total recognised gains and losses (in Old UK GAAP) or statement of changes in equity (in FRS 101, FRS 102 or IAS).
While FRS 105 doesn’t require a statement of changes in equity to be presented, it does require PPAs to be reflected in the accounts. They are reflected as restatement of comparative figures (if practicable), or as adjustments to the carrying amounts of assets and liabilities (as at the beginning of the earliest practicable period) with corresponding adjustments to the opening balance of the components of equity that are affected by the PPA.
No prior period adjustment
In some cases there may be no PPA even though there’s a change in accounting measurement for a particular instrument. For example, no PPA will be recognised where there’s a change to the overall accounting framework and the opening figures have been restated. This will often be the case where a company adopts IAS, FRS 101, FRS 102 or FRS 105 for the first time.
In these cases sections 315 to 319 CTA 2009 will apply. These calculate the transitional adjustment by comparing the opening accounting value in the current accounting period with the closing accounting value for the previous accounting period. Accounting carrying value is defined to mean the carrying value of the asset or liability as shown in the balance sheet of the company subject to adjustments for specific tax provisions which have the effect of changing the carrying value for tax purposes (for example, section 349 CTA 2009 for connected party debt).
The derivative contract regime has equivalent rules in section 597 and sections 613 to 615 CTA 2009. The overall effect in either case is to ensure that no amount should fall out of account as a result of a change in accounting policy.
The Corporate Finance Manual, CFM76000 onwards, has more details about the treatment of transitional adjustments for loan relationships and derivative contracts.
These provisions apply only to companies within the charge to Corporation Tax.