FRED 82 – What is changing?

Are you ready?

• What are the significant changes coming up in FRS 102?

  FRED 82 introduces two significant changes to the accounting requirements. These are for leases and revenue.

  Changes to Section 23 Revenue are based on the five-step model of revenue recognition that is within IFRS 15 Revenue from Contracts with Customers.

  Changes to Section 20 Leases are based on the on-balance sheet accounting model that is within IFRS 16 Leases.

  There are also some other incremental changes, tweaking other sections of the Standard, notably section 2A Fair Value Measurement.

• How will revenue recognition change?

  IFRS 15 is based on a control approach, with a five-step model:

  1. Identify the contract(s) with a customer.
  2. Identify the promises in the contract.
  3. Determine the transaction price.
  4. Allocate the transaction price to the promises in the contract.
  5. Recognise revenue when (or as) the entity satisfies a promise.

  There is no differentiation in revenue recognition for different categories of revenue, unlike in the current FRS 102 model.

  FRS 102 currently uses a risks and rewards approach, where the timing of revenue is different for each category – revenue from the sale of goods, revenue from services and construction contracts, and interest, royalties and dividends.

  The introduction of the IFRS 15 model for revenue recognition is expected to have a significant impact on revenue recognition for some entities.

• How will leases change?

  Currently, FRS 102 splits out the recognition of leases by two categories – finance leases and operating leases.  Whether a lease is an operating or finance lease depends upon the economic substance of the transaction.

  IFRS 16 however, has no differentiation between finance or operating leases.

  Contracts which meet the definition of a lease will recognise a right of use asset and a lease liability.

  The lease liability will be accounted for using the effective interest method, and so the interest cost is recognised in the statement of comprehensive income as well the as depreciation in relation to the right of use asset.

  There is however an exception to leases where the underlying asset is of ‘low value’ or the total lease term is 12 months or less. In these instances there is still an option to continue to follow operating lease accounting.

  Similarly to revenue, the introduction of the IFRS 16 model for leases is expected to have a significant impact for some entities.

• The changes to revenue and lease accounting could be significant, but is there anything else which may change?

  There are also some clarifications and improvements expected to other areas of FRS 102. The other key changes are:

  • A new section 2A Fair Value Measurement, which will reflect the principles of IFRS 13 Fair Value Measurement. The updated appendix provides more detail on measurement and valuation techniques.
  • Section 2 Concepts and Pervasive Principles is being updated to reflect the IASB’s conceptual Framework for Financial Reporting.
  • There will no longer be an option to newly adopt the recognition and measurement principles that are within IAS 39. However, those entities already applying the option now will be allowed to continue to do so.
  • There will be greater clarity on the disclosures required for small entities in the UK adopting FRS 102 Section 1A.

• What else might affect entities need to think about?

  The proposed changes are also expected to have a number of wider business impacts influencing business decisions, including:

  • There may be additional data requirements to keep track of revenue and lease contracts and/or other required data.  Any applicable increased disclosure requirements may also require additional data collection.
  • IT systems and processes may need to be reviewed to ensure that they are able to gather and process the required information.
  • Some of the changes may influence commercial negotiations and the structuring of arrangements.
  • Debt covenants and performance metrics may need to be renegotiated, such as those related to interest cover or EBITDA.
  • The revised profile of the income statement may affect the ability to pay dividends, particularly where depreciation and interest charges from lease accounting affect distributable reserves.

  Even where the adjustments required as a result of FRED 82 are insignificant, the wider impacts may result in additional resources or infrastructure that may take some time to integrate.