The advent of new Irish/UK GAAP is one of the biggest technical challenges faced by accountants and auditors for many years.
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This article seeks to alert readers to the first pronouncements by the CAI Professional Standards Department (PSD) and the ICAEW Quality Assurance Department (QAD) about FRS 102 reviews. These indicate that reviews of FRS 102 financial statements were generally reasonable, although they found several cases where documentation relating to the impact of transition was weak.
Auditors and prepares please take note of the following problem areas which reviewers found:
In some cases, the totals in the Statement of Financial Position, Total Comprehensive Income Statement and the Statement of Changes in Equity (SOCIE) don’t agree. Errors were also spotted in presentation of non-controlling interests (NCI), and in some cases, there was no disclosure of NCI, where it would have been relevant.
Misclassifications also occurred between profit or loss, other comprehensive income, and equity.
Accounting policy disclosures
Accounting policy disclosures are, generally, more detailed under FRS102. At one end of the scale many smaller SME clients have accounting policies that are largely unchanged from the previous audit year. At the larger company end, the policies were often up to date but sometimes incomplete.
Common omissions were:
- Significant judgements and key sources of estimation uncertainty in relation to amounts recognised in the financial statements (FRS 102.8.6 to 8.7);
- Where relevant, material uncertainties related to events or conditions that cast significant doubt upon the entity’s ability to continue as a going concern (FRS 102.3.8 to 3.9);
- The measurement basis (or bases) used for financial instruments and the other accounting policies used for financial instruments that are relevant to an understanding of the financial statements (FRS 102.11.40). See further in the paragraph below;
- Disclosures relating to creditors required by CA 2014 Schedule 3, such as terms of payment/repayment and the rate of any interest payable on debts.
On transition it is recommended that firms should review the impact of FRS 102 on accounting policies, ideally on a line by line basis e.g. mentioning the use of ‘fair value’ measurements rules for revenue and income (FRS 102.23). Also, remember to ask exploratory questions and look out for key indicators where accounting policy changes are more likely to be important, such as business combinations and goodwill, financial instruments, investment property and deferred tax.
Many entities have had little or no transition adjustments, although the impact of FRS 102 is not always clearly disclosed. If there are no transition adjustments, it is best practice to state this fact.
Better disclosure is sometimes needed where entities have numerous or complex transition adjustments. Disclosures also need to explain separately, any errors identified and corrected as part of the transition.
Financial instruments (including financing transactions and derivatives)
Disclosures around financial instruments often need some improvement, despite the fact that most private companies appear to have only to deal with basic financial instruments.
In particular, disclosures around long-term debt terms often need enhancing to include details of interest rate, maturity, repayment schedule and any associated restrictions, the debt places on the entity.
Financing transactions are a new concept which some firms are struggling with, although these transactions are fairly common in private entities. The reviewers say they sometimes have doubts about the presentation or the measurement of loans due to directors or group companies with no (or low) interest rates, which usually fit the definition. Firms should be challenging presentation of such loans as long term, when there is no formal written agreement setting out a repayment schedule at the year end.
Reviewers have not seen many examples of discounting, where loans (including financing transactions) are treated as long term. The impact is often argued to be immaterial, although it is suspected that difficulty with the calculations may be a factor.
Reviewers occasionally came across derivative financial instruments in private entities, for which recognition is mandatory in Irish/UK GAAP for the first time under FRS 102. These are mostly forward currency contracts. When no derivatives are recognised, it’s not always clear whether this is appropriate, either because the disclosures need enhancing, or because the firm may not have asked all the right questions and needs to gain a better understanding of its client.
Business combinations and goodwill
Some improvements are needed in goodwill disclosures. Useful life needs to be disclosed along with the reason for choosing that period. Disclosure of the reason was often missing when particularly important, because the useful life exceeded 10 years.
Some entities continued to assume that goodwill has an indefinite useful life (despite this no longer being allowed), even disclosing this as a departure from FRS 102. It is difficult to see that departure from the requirement to amortise goodwill is justified, particularly when no reason is disclosed.
Disclosures relating to business combinations are sometimes very weak. Detailed disclosure requirements omitted include the:
- name/description of combining entities;
- date of acquisition;
- percentage of voting instruments obtained;
- cost of combination; and
- amounts of assets and liabilities acquired.
There is little recognition of other intangibles as a result of business combinations. Restatement of business combinations in the year before first time adoption (post transition date) is also rare. Reviewers sometimes doubt the extent of firms’ enquiries and review of current and prior year business combinations to identify possible other intangible assets.
The reviewers came across significant errors in recognition of goodwill. Some firms did not know that Irish/UK GAAP no longer permits goodwill to be adjusted, when an entity increases or decreases its stake in a subsidiary, where there is no change in control (i.e. when the other entity was a subsidiary both before and after the transaction).
Any such transactions in the year before first time adoption (post transition date) should give rise to a transition adjustment. The difference between cost/proceeds and share of net assets acquired/ disposed, which could have been recognised as an addition or disposal of goodwill under old Irish/UK GAAP, is now recognised directly in equity.
Investment property and property, plant and equipment (PPE)
Gains and losses on investment property and PPE are sometimes incorrectly presented. Errors include taking investment property gains to Other Comprehensive Income rather than profit or loss and vice versa, in respect of PPE revaluations. In some cases, the disclosure of the current accounting policy and transition was unclear, where entities transitioned PPE using a past revaluation or fair value as deemed cost.
Deferred tax was not always recognised on unrealised gains in investment property or PPE when it should have been. Deferred tax should be recognised on all timing differences between taxable profits and total comprehensive income. Any unrealised gains of this nature existing at the transition date would give rise to a transition adjustment.
Errors occurred in presentation of the movement in the deferred tax provision. The deferred tax impact should be recognised as expense/income in the same component of total comprehensive income as the underlying transactions; apart from deferred tax arising on fair value adjustments as part of a business combination, in which case the goodwill is adjusted by the amount of deferred tax.
Don’t always blame the software
Problems with implementation of FRS 102 tend to stem primarily from weaknesses at a whole-firm level, including insufficient CPD, over-reliance on software and policies around preparation and review of financial statements.
While most firms visited had undertaken FRS 102-related CPD, in some cases further training is needed. This could be targeted on certain aspects, or a general refresher. Repetition of key messages in ongoing CPD helps them to sink in. Refresher training now should also pick up on the more recent developments in guidance and understanding of FRS 102 throughout the profession.
Accounting software is an invaluable tool, but is not fool proof and can’t do the whole job on its own. Some firms place too much reliance on their software, being quick to blame it for not picking up errors and omissions.
Comments from firms often focused on problems with the latest updates, including software not prompting or automating the required primary statements or disclosures; mapping problems leading to presentation errors; and inflexible accounts formats. Firms that plan ahead and implement enhanced review procedures, for example on first time adoption accounts, and make full use of disclosure checklists, have more chance of identifying problems at an early stage.
In some cases, the problems revealed by the reviews highlight the need for firms to obtain a better understanding of their clients. This means asking the right questions to ensure all the appropriate items are identified and recognised in the accounts. Knowing what questions to ask, ties in with CPD and familiarity with the standard.
And finally, if mistakes are made, it’s important to learn from them. Identification of root causes is an essential part of the process and this helps ensure the same mistakes aren’t repeated. A software weakness is unlikely to be the whole story.
Audit Update on 4 December 2017
Accounting Update for the Busy Accountant on 27 November 2017