FRS 102 changes for property companies

FRS 102 changes have brought some fundamental accounting changes that impact on property companies and investors.

FRS 102 is the Financial Reporting Standard that is applicable in the UK. The changes can bring different challenges to property valuations, investments, lease incentives and loans.

Presentational Differences

The most striking change to accounts prepared under FRS 102 will be presentational. The financial statements may now consist of an Income Statement (formerly the Profit and Loss account), a Statement of Comprehensive Income (formerly the Statement of Recognised Gains and Losses), a Statement of Cash Flows, a Statement of Financial Position (formerly the Balance Sheet) and a new primary Statement of Changes in Equity which brings to prominence information previous dealt with in the notes.

The new standard does allow more flexibility in the presentation of the accounts. It includes options to combine the Income Statement and Statement of Comprehensive Income and in some cases also combine the Statement of Changes in Equity into a Statement of Income and Retained Earnings. In addition, the standard does allow other titles to be used for the primary statements. So companies may decide to retain the existing terminology if it’s not misleading.

Key FRS 102 changes to accounting treatments for property companies

In addition to the presentational changes, there are some fundamental changes to accounting treatment that may impact on property companies outlined below.

Here we compare the old UK GAAP procedures with the new FRS 102 changes.

1. Property Valuations:

• UK GAAP

Property used in the business could be revalued or held at depreciated cost. If the revaluation model was used a full valuation was required at least every five years with an interim revaluation in year three, appreciation in value was taken to a revaluation reserve and unless there was a binding sale agreement in place there was no requirement to provide for deferred tax arising on disposal.

• FRS 102

Such property can still be revalued but if this treatment is adopted, future revaluations must take place to ensure that the carrying value is not materially different from the fair value of the property. All revaluation differences are taken to profit and loss rather than a revaluation reserve and in all cases, deferred taxation must be provided on all revaluation differences.

The result is that for companies that chose to revalue property, an annual valuation may be needed. Deferred tax will reduce the uplift in net assets arising from revaluation gains and the profit and loss reserve will be a mix of both distributable and non-distributable reserves.

The adoption of FRS 102 does provide an opportunity for some companies to enhance the value of their net assets as it is possible to carry out a one-off valuation of tangible fixed assets and regard them as deemed cost going forward, without having to adopt a revaluation policy.  Even after the impact of accounting for deferred tax on the gain, this could, in some cases, lead to a significant improvement to the net asset value of the business.

2. Investment Property:

• UK GAAP

Investment property was held at market value with movements in valuation taken to a revaluation reserve. There was no requirement to account for deferred tax on gains unless a property was subject to a sales agreement.

• FRS 102

Investment property must now be held at fair value and movements in the valuation are taken to profit and loss. Deferred tax is provided on all revalued assets. The definition of investment properties has been widened to include properties occupied by other group entities in the single entity accounts.

The practical impact of the change is that reported profits will be affected by revaluation movements and reserves will be a mix of both distributable and non-distributable profits.  This is likely to lead to increased volatility of reported results.  Also, the requirement to provide for deferred tax may reduce net assets especially in cases where there is a large historic revaluation reserve.

3. Lease Incentives:

• UK GAAP

The value of lease incentives were recognised on a straight-line basis up to the point when the lease resets to market rates (Commonly the first break clause).

• FRS 102

FRS 102 changes mean lease incentives are now recognised on a straight-line basis over the term of the whole lease.

In practice, this means profits in the lessee’s accounts will be reduced in the early period of the lease as an increased proportion of the lease incentive is deferred.  This may provide an advantageous tax cash flow benefit.

4. Loans bearing interest at below-market rates:

• UK GAAP

The capital element of such loans was treated as liabilities less capital repayments. Interest was charged through the profit and loss account on an accrual in accordance with the terms of the loan.

• FRS 102

The capital element of such loans was treated as liabilities less capital repayments. Interest was charged through the profit and loss account on an accrual in accordance with the terms of the loan.

The introduction of FRS 102 means that loans carrying no interest or interest terms that are materially below market rates such as group loans will be recorded at a discounted value that is lower than currently recognised under UK GAAP.  The difference will be treated as interest income when the loan is made with an interest expense charged in subsequent years.  It is possible that group may wish to treat “permanent” group debt as a capital contribution thus increasing the cost of investment in the parent and creating a capital reserve in the subsidiary company.

5. Loans with no fixed terms of repayment:

• UK GAAP

Commonly intercompany loans and loans between related parties lack formal documentation of terms. Such loans may have been disclosed as repayable within one year or after one year depending on the circumstances. In both cases, the loans were recognised as the capital or nominal value of the loan.

• FRS 102

Without the formal agreement of terms, it is likely that the loan will be recognised at its nominal value as a liability due within one year. If the loan is formally deferred it will be discounted and measured at an amortised cost but this may be difficult to determine especially when there are no fixed terms.

In practice, this change may have a detrimental effect on net current assets when group debt has previously been treated as a long term liability.  Unless this debt is treated as a capital contribution as noted above it is recommended that formal terms are established and potentially a market rate of interest for the borrowing applied.  In some circumstances using a minimum notice period of 53 weeks may alleviate the issue as the loan will be treated as due after one year but the discounting impact may be immaterial.

Effect of FRS 102 changes on property companies

As highlighted above the financial statements of property companies are very likely to be affected by the introductions of FRS 102.  In certain circumstances, this could have a detrimental impact on the business and affect banking covenants as reported profits are likely to become more volatile and the strength of the balance sheet may change.

If you would like to find out more about the FRS 102 changes brought about by the new standards, see our FRS 102 FAQs.

Feel free to get in touch with the property team at Price Bailey to help you understand how your business may be affected. We can provide guidance and advice on how best to manage the transition into the new reporting and accounting framework.