Financial Instruments under FRS 102

I presented a seminar a few weeks ago on changes to UK GAAP, primarily focusing on FRS102.

From previous reading it was obvious that adoption of FRS102 is going to have far reaching consequences to the accounts of many businesses, however there are a number of areas where there seem to be differing opinions on how the new standard should be applied.  Also, in my opinion, there are going to be consequences for many business which they have not fully grasped.

One of the areas which falls into this category is in respect of accounting for financial instruments.  Financial instruments covers things which would seem relatively simple like cash or amounts receivable together with those which most would expect to be more complicated such as derivatives.  There are different sections, 11 and 12 respectively, in FRS102 to deal with simple and more complex financial instruments, however just because something is a simple financial instrument doesn’t mean that there aren’t complexities.

If a transaction is not at a market rate then it is likely to be a financing transaction which means that it can’t just be recorded at cost like now.  A loan from a bank is still likely to be recorded at cost, however an interest free loan from or to a director would not be unless it was repayable on demand.    Many business won’t want loans that are repayable on demand for various reasons, including accounts presentation.  If a business had a loan from a director of £100,000 interest free for say three years it would not initially be recorded at £100,000 but a lower figure to reflect the implied interest on the loan.  The questions are what is the right rate of interest and also where should this journal be posted to?  FRS102 does not offer much guidance for either question.  The perceived wisdom is that usually the initial gain in this situation would go through the profit and loss account which would then be matched by the interest charged for the next three years, however there is another school of thought that this needn’t be the case for financing transactions from shareholders. If the initial gain was instead put to shareholders funds then the deduction for tax in future years of the interest is not tax neutral.  In any case even if tax neutral there will be timing differences to be considered.

Anyway, if businesses think that they might have transactions and balances that might be classified as financing transactions these should be looked at as soon as possible to determine what impact FRS102 will have.  I wouldn’t be surprised if further guidance is necessary regarding this or other matters in FRS102.

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