On 27th March 2024, the FRC issued amendments to UK GAAP. This follows extensive feedback from its published exposure draft FRED 82. The changes will impact all companies reporting under FRS 102 including small companies reporting under FRS 102 section 1A.
These amendments will become effective for periods beginning on or after 1 January 2026 with early adoption permitted, provided all amendments are applied at the same time.
What is changing?
The most significant changes to UK GAAP are changes in the recognition of revenue and leases to align more closely with IFRS 15 and 16, although the revenue recognition changes are expected to impact the Financial Services sector less than some other industries.
Leases
Leases will now be accounted for under the balance sheet model adopted by IFRS 16. This removes the differentiation between finance and operating leases and creates a ‘right-of-use asset’ on the balance sheet with a corresponding liability, meaning most lessees with operating leases will be impacted. The right-of-use fixed asset will be subject to depreciation and interest based on the liability will be charged to profit and loss, with the removal of the rent charges. With the exception of low value and short life assets this will impact all leases. Many Financial Service businesses have high value property leases and are expected to see significant changes, but all leases need to be considered in detail as this will also cover leases for assets, equipment and machinery.
Fair Value
A new framework for determining fair value has been introduced which has aligned the definition of fair value with IFRS 13 and provides further clarity and guidance on navigating the complexities of determining fair values. Whilst the core principals may not change this clarity could lead to some changes in determining fair value that impact on the reported profits.
Revenue Recognition
The revenue recognition model will follow the five-step model adopted under IFRS 15 to recognise and measure revenue based the fulfilment of performance obligations. It is not expected that this model will have a significant impact on the financial services sector, but it is still important that all contracts and performance obligations are reviewed to ensure that any potential changes are highlighted.
Impact on financial reporting and users of the accounts
The transition to these new standards will potentially impact on financial reporting, particularly those applying the new leases standard, which will impact some key ratios:
Impact on profit: The changes will have a positive effect on EBITDA as the rent expense is replaced with depreciation and interest that will be added back in this ratio.
Gearing: With the introduction of lease liabilities onto the balance sheet, this will set to increase the gearing ratio.
Interest Charges and Interest Cover Calculations: The increased interest charges will impact on the interest cover calculations, which could impact on their ability to meet interest obligations and comply with financial covenants.
Comparability: The transitional adjustments will not be applied retrospectively, meaning that the previous years results in the financial reporting with not be comparable, with the removal of rent charges and the addition of a right-of-use asset, lease liabilities, depreciation and interest charges.
Preparing for the implementation
Whilst these changes will not come into force until 1st January 2026, or sooner for short periods of accounts, it is important the companies thoroughly understand the requirements and plan accordingly for the transitional adjustments.
Companies should begin to consider the impact of the new standard on their current business models and communicate with relevant stakeholders the impact on metrics that are used to measurement performance, banking covenants and bonus/commission arrangements.
They should also ensure that their financial processes and systems capture the information you need for transition and on-going accounting. It is also important that contracts entered with customers or new leases signed are considered in light of the new principles.
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