Guidance

FRS 102 overview paper - Income Tax implications

Updated 21 July 2017

1. Introduction

The purpose of this overview paper (hereafter ‘the paper’) is to assist businesses who are thinking of choosing or have already chosen to apply Financial Reporting Standard (FRS) 102. In particular, it provides an overview of the key accounting changes and the key tax considerations that arise for those businesses that transition from ‘Old UK generally accepted accounting practice (GAAP)’ (defined, for the purposes of this paper), to FRS 102, see below.

This paper is split into 2 parts:

• part A provides a comparison of the accounting and tax differences that arise between Old UK GAAP and FRS 102
• part B provides a summary of the key accounting and tax considerations that arise on transition from Old UK GAAP to FRS 102

The paper concentrates on the Income Tax position for individuals, partnerships and non-resident companies within the charge to Income Tax. Not all of these are required to prepare accounts but all are required to calculate the profits of their business in accordance with GAAP with the exception of those using the ‘cash basis’. This paper doesn’t apply to those using the cash basis. GAAP includes FRS 102.

Separate papers have been prepared for UK companies moving to FRS 101 and FRS 102 as there are significant differences between the 2 tax regimes which are not reflected in this paper. In particular, for UK companies there are specific rules for loan relationships, derivative contracts and intangible fixed assets which only apply for the purposes of Corporation Tax.

This paper reflects the current thinking of HMRC and it’s based on the law as it stands at the date of publication. It’s intended that this paper will be updated as further information is available and as new accounting standards and tax law develop.

The government will continue to work with businesses and their advisers to assist with the tax issues that could arise on transition to the new accounting standards.

The commentary provided in the paper is of a general nature. Businesses shouldn’t rely on the commentary in isolation and it’s not intended as a substitute for referring to the accounting standards and tax law. Changing the basis on which accounts are prepared is a complex area and businesses may wish to consider discussing the implications of transition with their advisers and, or consult the detailed guidance in the HMRC manuals.

It remains the responsibility of the entity or individual to make sure that it prepares accounts in accordance with relevant GAAP and submits a self-assessment in line with UK tax law. Note that where HMRC considers that there is, or may have been, avoidance of tax the analysis as presented won’t necessarily apply.

2. Background

2.1 Interaction of accountancy standards with tax

Tax legislation for businesses requires that the profits of a trade and property business are calculated in accordance with GAAP, subject to any adjustment required or authorised by law in calculating profits for Income Tax purposes (section 25 and section 272 Income Tax (Trading and Other Income) Act 2005 (ITTOIA)).

GAAP for Income Tax purposes is defined at section 997 Income Tax Act 2007:

• and is UK GAAP - in relation to accounts of UK companies (other than International Accounting Standards (IAS) accounts) that are intended to give a true and fair view
• or, in relation to a company that prepares IAS accounts, means GAAP in relation to IAS accounts (note that for tax purposes individuals are not able to use IAS)

As noted above, the Income Tax treatment for businesses starts with the profits of the trade or property business calculated in accordance with GAAP.

2.2 Non-UK resident companies

It’s possible for companies’ resident outside of the UK to have a property business in the UK. Non-resident landlords, including non-resident companies are usually chargeable to Income Tax on the profits of their UK property business. For more information see Tax on your UK income if you live abroad.

The same statutory definition of GAAP applies to Income Tax and Corporation Tax. As such, where the non-resident landlord company prepares IAS accounts, these will be used to calculate profits; and in other cases, the profits for UK tax purposes must be calculated on the basis of UK GAAP. This includes cases where the non-resident landlord company prepares statutory accounts which are neither IAS or UK GAAP accounts. Note however that IAS accounts can’t be used for tax purposes by individuals.

2.3 Summary of the changes to the accounting standards

There currently exists a suite of accounting standards in the UK. Subject to certain restrictions detailed in the respective standards themselves, entities may choose or may be required to prepare their accounts under one of the following:

• European Union (EU) endorsed International Financial Reporting Standards (IFRS) and IAS: those accounts prepared in accordance with International Accounting Standards within the meaning of section 395 of the Companies Act. Hereafter ‘IAS’ for the purposes of this paper, note that for Income Tax purposes individuals are not able to use IAS
• New UK GAAP: FRS 100, FRS 101, FRS 102 and FRS 105, entities applying New UK GAAP will

Within the framework of FRS 100 apply one of the following:

• FRS 101 is effectively the recognition and measurement requirements of IAS subject to some changes to make sure of alignment with UK Companies Act and also reduced disclosure requirements. In the UK FRS 101 will only apply to companies within the charge to Corporation Tax and is therefore not considered further in this paper
• FRS 102 is a new suite of accounting requirements which are closely aligned to, but are not the same as IFRS
• section 1A of FRS 102, available to small entities, is aligned to FRS 102 but with reduced disclosures and presentation requirements
• FRS 105 is based on the recognition and measurement requirements of FRS 102, with some accounting simplifications and reduced disclosures for eligible micro-entities

Hereafter ‘New UK GAAP’ for the purposes of this paper.

• Old UK GAAP: substantively the FRS’s, SSAP’s, UITF’s and relevant accepted practice in existence and applied prior to the introduction of New UK GAAP, for purposes of this paper this is described as ‘Old UK GAAP’. This paper includes FRS 26 (and related standards) within its meaning of Old UK GAAP unless otherwise stated
• FRSSE: the Financial Reporting Standard for Smaller Entities, businesses that meet the eligibility criteria may prepare and file abbreviated accounts
• micro-entities: businesses that meet the eligibility criteria may prepare and file abridged accounts, with effect for periods commencing on or after 1 January 2016 these requirements are contained in FRS 105

For periods commencing on or after 1 January 2015 businesses are not permitted to prepare their accounts in accordance with Old UK GAAP. Instead such entities which applied Old UK GAAP will need to transition from Old UK GAAP to one of the alternatives. It’s expected that many businesses applying Old UK GAAP will transition to FRS 102.

For periods commencing on or after 1 January 2016 small entities won’t be permitted to prepare their accounts in accordance with the FRSSE. Instead such entities will need to transition to one of the New UK GAAP alternatives. It’s expected that many businesses applying FRSSE will transition to section 1A of FRS 102.

Transition to new UK GAAP will impact on the accounts in 2 key ways:

• assets and liabilities at the accounting transition date will be identified, recognised and measured in line with the requirements of the new standards
• thereafter, profits and losses will be recognised in accordance with the new standards - these may differ from those profits and losses that would have been reported had Old UK GAAP been retained

3. Part A comparison between Old UK GAAP and FRS 102

This part of the paper provides a comparison of the ongoing accounting and tax differences that arise between Old UK GAAP and FRS 102.

3.1 Reporting financial performance

The following section assumes that accounts are prepared for Income Tax purposes.

Although accounts are not always required for Income Tax purposes, tax legislation does, however, require that the profits of the trade or property business are calculated in accordance with GAAP. The exception to this is if the cash basis is adopted.

3.2 Old UK GAAP

Accounts prepared in accordance with Old UK GAAP are required to present, amongst other things, a profit and loss account, balance sheet and where applicable a statement of total recognised gains and losses (STRGL). The format of the profit and loss and balance sheet are determined by company law, whilst the format of the STRGL is set by FRS 3.

3.3 FRS 102 (excluding section 1A of FRS 102)

Accounts prepared under FRS 102 are also required to present a balance sheet (or ‘statement of financial position’). Section 5 of FRS 102 provides preparers with a policy choice of presenting its total comprehensive income for a period either as:

• a single statement of comprehensive income, in which case the statement presents all items of income and expense recognised in the period
• 2 statements; an income statement and a separate statement of comprehensive income

The single statement approach is akin to a combined profit and loss and STRGL while the 2 statement approach keeps them separate. FRS 102 differs from Old UK GAAP in this regard but it should be noted that for companies adopting FRS 102 the format requirements of the Companies Act still apply.

FRS 102 also requires that a statement of changes in equity is presented which captures an entity’s profit or loss for a reporting period, other comprehensive income (OCI) for the period, the effects of changes in accounting policies and corrections of material errors recognised in the period, and the amounts of investments by, and dividends and other distributions to, equity investors during the period.

While format requirements of the Companies Act remain in many cases the terminology used in FRS 102 differs from Old UK GAAP. As a result, it’s possible that certain items will be described differently compared with previously and from one entity to another. FRS 102 does permit the use of titles and descriptions that differ to those used in the standard itself, and some businesses may retain the Old UK GAAP descriptions.

The following table sets out the statements which are broadly equivalent:

Old UK GAAP	FRS 102
Profit and loss account	Income statement
Statement of total recognised gains and losses	Statement of comprehensive income (sometimes referred to as a statement of other comprehensive income)
Balance sheet	Statement of financial position
Cash flow statement	Statement of cash flows
Reconciliation of movements in capital account	Statement of changes in equity

Notes

1. As previously stated, section 5 of FRS 102, permits an entity to prepare a single performance statement rather than a separate income statement and a separate statement of comprehensive income, this combined statement is typically called a statement of comprehensive income or a statement of profit or loss and OCI.
2. In some circumstances FRS 102 allows an entity to produce a ‘statement of income and retained earnings’ in place of the statement of comprehensive income and the statement of changes in equity.
3. Appendix 3 of FRS 102 provides a comparison table of Companies Act terminology and FRS 102 terminology.

3.4 Section 1A of FRS 102

Those entities preparing their accounts using section 1A of FRS 102 will only have to present a balance sheet, profit and loss account and limited notes. They won’t be required to present any other primary statements but are encouraged to present a statement of comprehensive income (sometimes referred to as the statement of total recognised gains and losses) and a statement showing changes in equity.

They will also have the option of presenting an abridged balance sheet and profit and loss account.

The abridged balance sheet includes the main headings only (intangible assets, tangible assets, investments, stocks, debtors, cash, prepayments, creditors, provisions, accruals, equity, capital, members’ current account, revaluation reserve, other reserves and profit and loss reserve). No further analysis of these headings is required.

The abridged profit and loss account starts with a single figure for ‘gross profit or loss and other operating income’. There is no separate disclosure of turnover, cost of sales and other operating income.

3.5 Tax position

While the references and titles used in FRS 102 are aligned to those used in IAS the tax statute has been updated to cover both sets of terminology. A reference in statute to the ‘income statement’, for example, will take its normal accounting meaning. Furthermore, the reduced disclosure requirements permitted by section 1A of FRS 102 wouldn’t typically have any effect on the business’s tax position.

4. Accounting policies, estimates and errors

4.1 Accounting for a change in accounting policy

FRS 3, Reporting financial performance, requires that changes in accounting policy are applied retrospectively and that the cumulative effect of prior period adjustments are presented at the foot of the STRGL.

Section 10 of FRS 102 requires that a change in accounting policy resulting from a change in the requirements of an FRS or FRC abstract is accounted for in line with the requirements of that revised FRS or FRC abstract.

When the standard doesn’t contain specific requirements, the change in policy, in a manner comparable to Old UK GAAP, will be applied retrospectively to the earliest date which is practicable as if the new policy had always applied.

However, while the requirement to apply the policy retrospectively is comparable between Old UK GAAP and FRS 102 there is a difference in how this is presented. As noted above, under Old UK GAAP, FRS 3 requires that the cumulative effects of prior period adjustments are presented at the foot of the STRGL. In contrast FRS 102 requires that the change is recognised in the statement of change in equity.

4.2 Accounting for change in estimate

Old UK GAAP requires that a change in estimate is applied prospectively. For example where an entity changes the useful estimated life of a tangible fixed asset it doesn’t adjust the depreciation brought forward. Instead the depreciation is adjusted prospectively to reflect the revised useful economic life.

FRS 102 is consistent with Old UK GAAP in this regard.

4.3 Accounting for errors

Where a fundamental error is identified FRS 3 requires that this is accounted for by restating prior periods’ comparative figures. Errors that are not considered fundamental are accounted for in the period they’re identified. Section 10 of FRS 102 requires that, to the extent practical, an entity shall correct material errors retrospectively in the first financial statements authorised for issue after the error is discovered through restating the comparative amounts for the prior period. Errors that are not considered to represent material errors are accounted for in the period they’re identified.

4.4 Tax treatment

For trading profit Chapter 17 Part 2 ITTOIA provides that where there is a change from one valid basis on which the profits of a trade are calculated to another valid basis (for example on a change of accounting policy), an adjustment must be calculated to make sure that business receipts will be taxed once and once only and deductions will be given once and once only. For Income Tax purposes an adjustment resulting in a profit is subject to a standalone tax charge as ‘adjustment income’ and a negative adjustment is treated as an allowable deduction in computing the profits of the trade.

That approach will continue to apply for prior period adjustments arising in accordance with section 10 of FRS 102.

The above applies to changes from one valid basis to another. Where the change is from an invalid basis (such as may occur when a material error is identified in the accounts), UK tax law requires the invalid basis to be corrected in the year it first occurred with subsequent periods restated. Whether tax can be collected or repayments claimed is dependent on the time limits for making or amending assessments.

For property businesses within the charge to Income Tax income Chapter 7 Part 3 ITTOIA deal with adjustment income or expenditure where the basis on which the profits are calculated changes.

5. Financial instruments

5.1 Introduction

In accounting terms, a financial instrument is a contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another. Examples of common financial instruments include; cash, trade debtors, trade creditors, bonds, debt instruments and derivatives.

Businesses applying Old UK GAAP fell into 2 main camps - those applying FRS 26 and those that don’t. Businesses that have not adopted FRS 26 are likely to see the largest changes as a result of adopting FRS 102. Furthermore, under FRS 102 a business effectively has 3 options for the accounting of financial instruments:

• sections 11 and 12 of FRS 102
• IAS 39
• IFRS 9

This means that there are 6 possibilities for transitioning from Old UK GAAP to FRS 102.

This chapter of the paper concentrates on those businesses which don’t currently apply FRS 26 as it’s likely that these businesses will see the biggest change. The paper covers both the sections 11 and 12 and the IAS 39 options under FRS 102. This paper doesn’t consider the accounting and tax interaction where the third option, IFRS 9, is adopted.

Note that this paper deals with borrowing costs in chapter 13, foreign currency transactions in chapter 16 and liability and equity in chapter 17.

5.2 General requirements - Old UK GAAP

As noted above, for businesses applying Old UK GAAP the accounting for financial instruments can be segregated into 2 camps - those that apply FRS 26 and those that don’t.

FRS 26 is aligned to IAS 39 and is mandatory for companies with listed debt or equity that are not using IAS. It’s optional for all other entities.

For businesses not applying FRS 26 there is no specific, comprehensive standard for financial instruments in Old UK GAAP. Instead accounting for financial instruments is primarily determined by the requirements of FRS 4 (issuer of capital instruments), SSAP 20 (foreign currency transactions), FRS 5 (substance over form, including some recognition or derecognition issues).

Otherwise, for businesses not applying FRS 26, the accounting for financial instruments is based largely on the general principles in FRS 18, particularly the accruals concept.

5.3 General requirements - FRS 102

In contrast to Old UK GAAP (where FRS 26 isn’t adopted) FRS 102 provides a business with specific guidance on accounting for all financial instruments. In section 11 it provides 3 accounting options application of:

• sections 11 and 12 of FRS 102
• the recognition and measurement criteria of IAS 39
• the recognition and measurement criteria of IFRS 9 (and IAS 39 as amended for IFRS 9)

5.4 General requirements - sections 11 and 12 options

Sections 11 and 12 within FRS 102 provide specific information on accounting for financial instruments. Section 11 addresses ‘basic’ financial instruments while section 12 considers all ‘other’ financial instruments. While sections 11 and 12 address accounting for financial instruments, there are certain exceptions to their scope including insurance contracts, investments in subsidiaries, associates and joint ventures and leases (for a comprehensive list see sections 11.7 and 12.3 of FRS 102). Section 12 does however apply, for example, to all derivative financial instruments.

‘Basic’ financial instruments are those considered to have straightforward terms - examples provided in section 11 include cash, trade debtors, trade creditors and simple bank loans with standard repayment conditions. Such instruments are typically recognised at transaction price and measured on an amortised cost basis. This is largely consistent with Old UK GAAP.

‘Other’ or ‘non-basic’ financial instruments refer to all other financial instruments. In contrast to ‘basic’ financial instruments, ‘other’ financial instruments are typically recognised and subsequently measured at fair value, with changes in fair value reflected in the profit and loss. In particular the following are examples of instruments which will now be held at fair value in accordance with section 12 of FRS 102:

• all derivatives (including interest rate swaps; a forward commitment to purchase a commodity that is capable of being cash-settled; options and forward contracts)
• loans that are not plain vanilla debt - where, for example, the amount repayable can vary or where non-standard interest rates are used
• investments in convertible debt where the return to the holder can vary with the price of the issuer’s equity shares rather than just with market interest rates - (note that where the convertible debt is a compound financial instrument the accounting in the issuer will also be determined by reference to section 22 of FRS 102)

The requirements of section 12 of FRS 102 represent a significant change from Old UK GAAP (both where FRS 26 has and has not been adopted). It’s likely that many more financial instruments will be required to be fair valued under FRS 102 than was the case under Old UK GAAP.

5.5 General requirements - IAS 39 option

This option won’t apply to individuals.

As noted above FRS 102 also permits a user to make the policy decision to apply the recognition and measurement criteria of IAS 39. Although IAS 39 doesn’t distinguish between ‘basic’ and ‘other’ financial instruments in the same way it does share some similarities with section 12 of FRS 102; for example in both cases, an entity will typically be required to account for all financial instruments separately whereas synthetic or composite instruments are relatively common under Old GAAP (where FRS 26 isn’t adopted). Below are the characteristics that would result in a financial instrument being measured at fair value under IAS 39:

• assets and liabilities held for trading purposes or speculatively
• assets and liabilities designated at the outset by the business as at fair value through profit and loss
• all derivative financial instruments

Note that under the IAS 39 option, debt instruments designated or classified as ‘Available for Sale’ (AFS) will be measured at fair value with fair value gains and losses recognised directly in OCI while interest income, foreign exchange and impairment losses will continue to be recognised in profit or loss.

Again this represents a significant change from Old UK GAAP (where FRS 26 isn’t adopted).

5.6 Tax treatment

For businesses within the charge to Income Tax there is no equivalent to the loan relationships (under Part 5 CTA 2009), non-lending money debts (treated as loan relationships under Chapter 2 of Part 6 CTA 2009) or derivative contracts (under Part 7 CTA 2009) legislation which apply to companies within the charge to Corporation Tax. This may lead to significant differences from Corporation Tax in tax treatment. In particular, items which are capital in nature will generally not be taken into account for Income Tax purposes.

Section 25 of ITTOIA requires that the profits of the trade are calculated in accordance with GAAP and these are then adjusted as authorised or required by tax law.

This means that only profit and loss account entries will be considered in the calculation of the profits of the trade calculated in accordance with GAAP.

The next step to consider is whether there is any adjustment authorised or required by tax law. For example items that are capital in nature will be adjusted for in the tax computation (section 33 ITTOIA) and expenses have to be incurred wholly and exclusively for the purposes of the trade (section 34 ITTOIA).

Tax legislation at section 29 ITTOIA says that, for calculating the profits of a trade, interest is always a revenue (as opposed to capital) item.

Section 58 allows incidental costs of finance by means of a loan or the issue of loan stock to be allowable deductions in calculating the profits of a trade. Sums paid because of losses resulting from movements in the rate of exchange between different currencies and sums paid for protection against such losses are not incidental costs of obtaining finance, see section 18.

The distinction between capital and revenue items is an important one for Financial Instruments as this will to a large extent determine the tax treatment. What constitutes a capital item isn’t defined by statute and there is no single test that will determine the issue in all circumstances. Further guidance on the principles and criteria which need to be considered can be found in HMRC’s Business Income Manual at BIM35000 onwards.

Some indicators of whether borrowing is of a capital or revenue nature are as follows.

Capital borrowing will be:

• not temporary
• fixed in amount
• available for use in any of the trader’s activities and not merely the day-to-day trading operations

An example of capital borrowing would be a long term loan of fixed amount which is used to enlarge the capital employed in the trade.

Revenue borrowing will be:

• temporary
• fluctuating
• incurred as an incident of carrying on the business’ day-to-day activities

An example of revenue borrowing would be a bank overdraft facility.

5.7 Debt restructuring and derecognition

Debt may be restructured or have its terms modified such that, in accordance with FRS 5 and Old UK GAAP (where FRS 26 isn’t adopted), no gain or loss would be recognised in the accounts.

In contrast, FRS 102 requires that, where the modification or restructuring to the debt is considered substantial, the original debt instrument will be derecognised and the ‘new’ debt instrument recognised at its fair value. To the extent that the fair value of the new instrument differs from the carrying value of the original debt instrument a gain or loss will typically be recognised as an item of profit or loss.

5.8 Tax treatment

Whether or not the gain or loss arising on the fair value recognition of the new debt instrument is taken into account for Income Tax purposes will depend on whether the gain or loss relates to a borrowing of a capital nature or borrowing of a revenue nature.

Further information on whether borrowing is of a capital or revenue nature see section 5.6.

5.9 Transition

On transition section 35 of FRS 102 provides that financial assets and liabilities derecognised under the previous accounting framework shall not be recognised on adoption of FRS 102. Section 35 also provides that where a financial asset or liability would have been derecognised under FRS 102 but under the business’s previous accounting framework had not been derecognised a business may, on transition, either:

• derecognise the financial asset or liability on adoption of FRS 102
• continue to recognise until disposed of or settled

However, no exclusions apply where the derecognition occurs after the accounting transition date, meaning after the start of the prior period comparatives. As a result, the business may be required to derecognise or recognise the debt.

For further information on the provisions applying to transitional adjustments see part B.

5.10 Initial recognition - non-market instruments

Old UK GAAP, where FRS 26 isn’t applied, typically requires that financial instruments are initially recognised at cost. This cost may or may not equate to the fair value of the financial instrument.

In contrast under FRS 102, whether through the application of section 11 and section 12 or through the IAS 39 option, financial instruments are typically measured on initial recognition at:

• transaction price
• present value (if there is a financing element)
• fair value

The transaction price (or ‘cost’) will typically, but may not always, equate to the present value or fair value of the instrument. Where the transaction price differs from the present value or fair value of the instrument it’s possible that a day one gain or loss could arise. For example, this can be an issue with non-interest bearing debts which are not repayable on demand.

5.11 Tax treatment

Whether or not the gain or loss arising on initial recognition of the financial instrument is taken into account for Income Tax purposes will depend on whether gain or loss relates to a capital item or a revenue item.

Further information on whether an item is of a capital or revenue nature can be found under ’Tax treatment’ see section 5.6.

Where a business has entered into a loan on interest-free terms, and this is accounted for under FRS 102 as a financing transaction, the notional interest debited as an expense to the Income Statement as the loan is returned back to its face value over the period to maturity isn’t an allowable deduction for tax. As there is no outlay, no expense has been incurred for the purposes of the business (section 34 ITTOIA).

5.12 Transition

Potentially this could result in a transitional adjustment. For further information on the provisions applying to transitional adjustments see part B.

5.13 Hedging relationships or synthetic instruments

Old UK GAAP, where FRS 26 has not been adopted, requires derivatives that are entered into as part of a business’ hedging strategy to be accounted for on an historic cost basis equivalent to that used for the underlying asset, liability, position or cash flow.

In contrast, both section 12 of FRS 102 and the IAS 39 option typically require all derivatives to be accounted for separately and to be measured at fair value. Section 12 of FRS 102 and IAS 39 both then provide certain ‘hedge accounting’ rules.

Under IAS 39 or FRS 102 hedge accounting is only permitted where certain criteria are met. However as part of the amendments made to FRS 102 in July 2014 the criteria were changed making hedge accounting more readily available to entities.

5.14 Tax treatment

Hedge accounting can be used as prescribed in section 12 of FRS 102 and IAS 39 in calculating the profits of the trade or property business in accordance with GAAP (IFRS 9 may also be adopted but this paper doesn’t consider the tax treatment). In this case, the taxable profits would typically be based on the amounts recognised in profit or loss, and wouldn’t include amounts in OCI . The general principles outlined at section 5.6 will, however, need to be considered when determining whether or not any fair value gains or losses recognised as items of profit or loss or amounts recycled from OCI will be taken into account for Income Tax purposes.

5.15 Cash flow hedge accounting

Where a cash flow hedge (such as where floating rate interest rate risk is hedged through an interest rate swap) is designated in such a way as to qualify for hedge accounting, the fair value movement of the hedging instrument recognised in other comprehensive income won’t be taken into account for tax purposes.

Where any gain or loss on the hedging instrument is subsequently transferred or ’recycled’ to profit or loss, the general principles outlined at section 5.6 will need to be considered when determining whether or not the gain or loss will be taken into account for Income Tax purposes. This also applies to receipts and payments under the hedging instrument as these payments are not interest.

As an example, many non-resident companies with UK property businesses will have entered into an interest rate swap to hedge the interest cost of borrowing at a floating rate to fund the purchase of rental property.

The interest payable under the loan is revenue in nature for the purposes of calculating the business profit. As the interest rate swap is taken out to hedge interest payments which are deductible in computing the profits, any periodic payments made or received under the interest swap contract will also be deductible or taxable as a revenue item. Similarly, fair value gains and losses from the interest swap contract which are ’recycled’ to profit and loss from other comprehensive income will also be revenue in nature and taken into account for Income Tax purposes.

5.16 Fair value hedge accounting

Where a fair value hedge (such as where a fixed loan rate is hedged through an interest rate swap) is designated in such a way as to qualify for hedge accounting, the fair value movement in both the loan and the hedging instrument is recognised in the profit or loss. As is the case for a cash flow hedge, the general principles outlined at section 5.6 (in particular the capital or revenue nature of the item being hedged) will need to be considered when determining whether or not the gain or loss, and any receipts and payments under the hedging instrument, will be taken into account for Income Tax purposes.

If, for example, the non-resident company in the example above had funded the purchase of a property with a fixed rate loan it may decide to enter into an interest rate swap at a variable rate.

The loan would typically be capital in nature (not temporary, fixed in amount) but it would be measured in the accounts at fair value. Any fair value movement on the loan will be capital in nature and not taken into account for Income Tax purposes.

The interest payable is revenue in nature for the purposes of calculating the business profit. As the interest rate swap is taken out to hedge interest payments which are deductible in computing the profits, any periodic payments made or received under the interest swap contract will also be deductible or taxable as a revenue item.

However, fair value movements on the swap instrument which relate to the loan value will be capital in nature so won’t be taken into account for Income Tax purposes. If the hedge is 100% effective, the fair value movement on the loan and swap should net off.

Note there is further guidance on the tax treatment of swap contracts held by unincorporated property businesses in HMRC’s Property Income Manual at PIM2140.

5.17 Transition

Potentially this could result in a transitional adjustment. For further guidance on the provisions applying to transitional adjustments see part B for more information.

5.18 Hybrid instruments and embedded derivatives

This paper doesn’t address in detail the position of hybrid instruments and embedded derivatives. This is a complex area and affected businesses will need to consider the accounting and tax treatment carefully. In overview, FRS 26 and IAS 39 require businesses to separate out (‘bifurcate’) embedded derivatives from host contracts. However, bifurcation isn’t typically permitted under Old UK GAAP (where FRS 26 isn’t applied) nor required by sections 11 and 12 of FRS 102 (although in both cases the issuer of compound instruments will still separate out the equity component in accordance with FRS 25 or section 22 respectively).

5.19 Businesses that currently apply FRS 26

The above commentary focuses on businesses that don’t currently apply FRS 26. Businesses that have adopted FRS 26 and choose to apply the IAS 39 option under FRS 102 are likely to see no change in the accounting of financial instruments. For those that choose to apply the sections 11 and 12 option certain elements won’t change but the basic or other distinction has the potential to result in significant changes. For example, such businesses could see the following differences as noted above:

• financial instruments are required to be fair valued under section 12 for all but ‘basic’ instruments. Loans previously recognised on an amortised cost basis may therefore be measured at fair value in accordance with section 12
• sections 11 and 12 don’t require the bifurcation of embedded derivatives (although the issuer of compound instruments will still separate out the equity component under section 22) - for example the holder of a hybrid financial instrument is required under FRS 26 to bifurcate the instrument into its host debt and embedded derivative. The host debt is then measured on an amortised cost basis and the embedded derivative at fair value. In contrast FRS 102 section 12 there is no equivalent requirement to split the instrument for accounting purposes
• the types of hedging relationships that are permitted under sections 11 and 12 are limited to certain risks (interest rates, foreign exchange, and commodity prices)

As such, transitional adjustment may arise - see part B for more information.

6. Inventories - stock

Section 13 of FRS 102 differs from SSAP 9 insofar as it specifically excludes from its scope Work in Progress in the course of construction contracts (covered in section 23 of FRS 102), agricultural produce and biological assets (covered in section 34 of FRS 102) and financial instruments (section 11 and 12 of FRS 102).

For many entities these differences will have no impact on the recognition or measurement of stock.

However entities operating in the agriculture sector, for example, may, in accordance with FRS 102, apply either a cost model or a fair value model. The use of the fair value model is likely to represent a significant change in the measurement basis of stock and hence the timing of profits or losses on such stock.

6.1 Tax treatment

However, while such accounting differences exist, typically stock is measured for accounting purposes at the lower of cost and net realisable value and this is followed for tax purposes. For more guidance on stock valuation for farmers see HMRC’s Business Income Manual at BIM55410.

7. Investment property

Old UK GAAP (SSAP 19) requires an entity to carry investment property at their open market value with movements in value recognised each period in the statement of total recognised gains and losses unless they represent a permanent diminution in value in which case they’re recognised in the profit and loss account. Where investment properties are let to and occupied by another group entity for its own purpose, SSAP 19 contains an exemption which excludes such properties from its scope (hence they would be included as part of fixed assets). FRS 102 requires that investment property is initially recognised at cost (if payment terms are deferred beyond normal credit terms, the cost is determined by reference to the present value of the future payments) and subsequently measured at fair value. However in contrast to SSAP 19, FRS 102 section 16 requires those fair value movements to be recognised in the profit and loss account. In addition FRS 102 section 16 doesn’t contain an exemption comparable to that present in SSAP 19 for property let to and occupied by group entities. Hence certain properties treated as fixed assets under Old UK GAAP may now be classified as investment property under section 16 of FRS 102.

Note that FRS 102 section 16 does permit the use of the cost model where the fair value can’t be reliably measured without undue cost or effort.

7.1 Tax treatment

However the accounting treatment of investment properties doesn’t determine, for tax purposes, whether the property is an investment property or whether a disposal of a property is a capital or a revenue disposal. For tax purposes income arising on an investment property is bought into tax as it’s recognised in the accounts (for example rental income would be bought into tax as recognised in the profit and loss account). Movements in fair value of investment properties are not taxable as these are capital in nature. On disposal investment properties are subject to capital gains.

In certain circumstances a business holding investment property as a lessee under an operating lease may, under section 16 for FRS 102, account for it as an investment property. Where it does so, the property is initially recognised at the lower of its fair value and the present value of the minimum lease payments. The corresponding creditor is accounted for as a finance lease (see section 20 of FRS 102). Where this happens the tax rules applying to finance leases will apply.

8. Property, plant and equipment

Section 17 of FRS 102 and FRS 15 are primarily about Property, plant and equipment (‘PPE’) or ‘fixed assets’ to use the Companies Act and FRS 15 terminology. Both standards are broadly consistent in principle. However differences are present in particular:

• section 17 of FRS 102 requires that major spare parts are included in PPE
• section 17 of FRS 102 requires that cost is measured by reference to the present value of all future payments where the asset is acquired under terms beyond normal credit terms
• section 17 of FRS 102 doesn’t permit the use of Renewals Accounting
• section 17 requires that residual values are based on current prices rather than historic prices

8.1 Tax treatment

While such differences for accounting purposes are present, UK tax law departs from the accounting standards by disallowing depreciation and revaluations of capital assets as these are capital in nature, and instead granting capital allowances (on some assets). Hence accounting changes are not expected to have a significant tax impact. In some cases where ‘revenue’ expenditure is added to the cost of an asset, tax law follows the accounts by recognising for tax purposes amounts reflected in profit and loss account by way of depreciation charge to the extent that they’re a write off of revenue expenditure. In those cases where depreciation under section 17 of FRS 102 differs from that under FRS 15 (for example because of revaluation of residual values) tax will follow the amount as per section 17 of FRS 102.

As noted above there is no equivalent to ‘Renewals’ accounting (FRS 15 paragraph 97 to 99) under section 17 of FRS 102 so there may be an adjustment for tax purposes made under the change of basis legislation - for more information see part B.

9. Intangible assets including goodwill

9.1 Intangible assets and goodwill arising on business combinations

The definition of an intangible asset in Old UK GAAP (FRS 10) states that intangible asset are ‘Non-financial fixed assets that don’t have physical substance but are identifiable and are controlled by the entity through custody or legal rights.’’

FRS 102 defines an intangible asset (other than goodwill) as an ‘identifiable non-monetary asset without physical substance’ where ’identifiable’’ is an asset that is separable or arises from a legal contract or other legal right. This definition is different from that present in Old UK GAAP in so far as the intangible asset need not be separable from the business. Consequently either on transition (where the exemption to retain previous GAAP figures isn’t used) or on subsequent business combinations, more intangible assets may be recognised under FRS 102 than would have been recognised under Old UK GAAP.

9.2 Tax treatment

For Income Tax purposes there is no equivalent to sections 871 to 879 of Part 8 CTA 2009 which provide a comprehensive set of rules for changes in accounting for intangibles and especially for cases where what is included entirely as goodwill under Old UK GAAP is disaggregated into different types of intangible property with different amortisation rates or impairment factors under FRS 102. Instead tax law will determine whether any adjustment is required to the calculation of the profits of the trade or property business calculated in accordance with GAAP, in particular the capital revenue divide.

9.3 Intangible assets and goodwill - useful economic life (UEL)

FRS 10 states that goodwill and intangibles should be amortised over their UEL. It also states that there is a rebuttable presumption that the UEL won’t exceed 20 years. FRS 10 does permit the use of an indefinite UEL in which case it’s amortised but is instead subject to annual impairment reviews.

FRS 102 differs from Old UK GAAP in respect of UEL. Firstly FRS 102 doesn’t permit an indefinite life. All intangibles and goodwill are presumed to have a finite life and the period over which they’re subject to amortisation should reflect this. Where the useful life of the intangible asset can be reliably estimated this life is used as the UEL. Where a reliable estimate of the UEL can’t be made, FRS 102 states that the UEL mustn’t exceed 10 years for periods commencing on or after 1 January 2016 (note 5 years for periods commencing prior to 1 January 2016).

9.4 Tax treatment

As above for Income Tax purposes the amortisation of a capital item wouldn’t be an allowable deduction for Income Tax purposes.

9.5 Software costs

FRS 10 requires that software costs which are directly attributable to bringing an item of IT into use within the business are recognised as part of tangible fixed assets. Where such costs did not relate to bringing an item of IT into use they would typically have been written off direct to the profit and loss. In addition UITF 29 provides that, where certain criteria are met, website development costs are recognised as part of tangible fixed assets.

9.6 Tax treatment

FRS 102 doesn’t specify how such costs should be treated. Hence the nature of the item should be considered in determining its treatment. For more guidance see HMRC’s Business Income Manual at BIM35800 onwards for the tax treatment.

10. Business combinations

Section 18 of FRS 102 is broadly comparable to FRS 6 and FRS 7. However particular differences are present:

• because of the difference in the definition of an intangible asset an acquisition under FRS 102 may result in a different balancing figure being assigned to goodwill on a business combination
• there is a change in the measurement of the consideration given where that consideration is contingent
• the look back period in which provisional fair values can be amended is different (FRS 102 look back period is 12 months since acquisition date)
• a change in step acquisitions in some circumstances

FRS 6 and 7 of Old UK GAAP are relevant in UK tax law only where the carrying value of an asset or liability acquired in a business combination is relevant for tax purposes, for example for loan relationships. This also applies where a business is applying FRS 102.

10.1 Tax treatment

The acquisition of a business is a capital expense for tax purposes.

Tax law determines the value of trading stock for the business ceasing and its value for the successor business - see Chapter 11A Part 2 ITTOIA.

11. Leases

Entities that apply Old UK GAAP will use SSAP 21, UITF 28 and FRS 5 in determining the accounting treatment of leases. Entities that adopt FRS 102 will apply the recognition and measurement requirements of section 20. Both Old UK GAAP and FRS 102 consider whether a lease transfers substantively the risks and rewards of the leased asset. However it should be noted that SSAP 21 includes a presumption that if the present value of the minimum lease payments is 90% or more of the fair value of the leased asset that it would typically be classified as a finance lease. Section 20 of FRS 102 doesn’t contain this presumption.

However the emphasis on the transfer of risk and rewards is such that in most cases the classification of leases will be consistent between Old UK GAAP and FRS 102. Once the lease has been classified the accounting treatment thereafter is also, generally, comparable. However differences, even where the classification is the same, do exist and the interaction with tax is noted below.

UITF 28 requires that operating lease incentives in the lessee are spread over the period ending on the date from which it’s expected that the prevailing market rent will be payable (if this period is shorter than the lease term, otherwise over the lease term).

Section 20 of FRS 102 requires that lease incentives are spread over the term of the lease unless another way would better reflect the reality. Consequently there may be differences for the period over which such incentives are recognised.

Since the accounting is followed where the incentive isn’t capital (for example a rent free period) the difference may alter the timing of income recognition for tax purposes.

UK tax law isn’t entirely consistent with SSAP 21 (see Statement of Practice 3 (1991)). But accounts figures are recognised for the purposes of Chapter 10A Part 2 ITTOIA which deals with leasing and finance leases with return in a capital form.

For lessors, FRS 102 section 20 requires use of the ‘net investment’ method for finance leases, whilst SSAP 21 requires the ‘net cash investment method’. There may be differences in the timing of income recognition under the 2 bases. In some cases these affect the timing of income for tax purposes, for example where Schedule 12 Finance Act 1997 applies.

11.1 Tax treatment

Legislation in sections 228B to 228F Capital Allowances Act 2001, and Chapter 5A Part 12 ICTA (inserted by FA 2006) brings the tax treatment of both lessors and lessees of finance leases of plant and machinery into line with the accounting basis in FRS 102 section 20 or SSAP 21 as appropriate.

Note that it’s not envisaged that section 53 FA11 (which deals with leasing and changes to accounting standards) will apply to entities on transition to section 20 of FRS 102 by virtue of subsection 3 of section 53 FA11.

12. Provisions

There are no significant differences between section 21 of FRS 102 and FRS 12.

12.1 Tax treatment

For tax purposes the recognition and measurement of provisions in the accounts forms the basis for the quantum and timing of tax relief (subject to adjustment where the expenditure is capital for tax purposes or otherwise disallowable).

Consequently, for most businesses it’s not expected that FRS 102 will have a significant tax impact in this area.

13. Revenue recognition

In general, reporting of revenue in accounts is followed for tax purposes. There is no specific standard for revenue recognition in Old UK GAAP. However, application note G of FRS 5 provides revenue recognition guidance about the sale of goods and services as well as other specific revenue recognition scenarios, SSAP 9 provides guidance about long term contracts and UITF 40 addresses service contracts.

The general principles of revenue recognition within FRS 5 application note G are that revenue is recognised when the seller obtains the right to consideration in exchange for the goods, services, or work performed. The right to consideration typically derives from the performance of its obligations under the terms of the exchange with the customer. FRS 5 application note G requires that, on recognition, revenue is measured at the fair value of the consideration received or receivable.

Revenue recognition under FRS 102 will primarily be determined by section 23 of FRS 102. The recognition criteria within section 23 are broadly aligned with Old UK GAAP. In addition, where the respective recognition criteria are met, section 23 also requires that revenue is recognised at the fair value of the consideration received or receivable.

Hence while there are a few differences between Old UK GAAP and FRS 102 (for example the latter expressively addresses and defines construction contracts in section 23), for many entities there will be no change following adoption of FRS 102.

13.1 Tax treatment

Consequently for many businesses there will be no accounting or tax impact.

14. Government grants

SSAP 4 requires that grants are recognised when there is reasonable assurance that related conditions, if any, will be met. Where reasonable assurance is present grants are then recognised in the accounts based on the relationship between the grant and the related expenditure.

FRS 102 section 24 states that the grant won’t be recognised until the entity has reasonable assurance that it will or has complied with the grant conditions and that the grants will be received. It requires that an entity adopts either the accruals or performance model to determine the subsequent accounting for the grant. Under the accruals model grants relating to revenue are recognised in income on a systematic basis over the periods in which the entity recognises the relevant grant costs. Under the performance model section 24 of FRS 102 states:

• a grant that doesn’t impose specified future performance-related conditions on the recipient is recognised in income when the grant proceeds are received or receivable
• a grant that imposes specified future performance-related conditions on the recipient is recognised in income only when the performance-related conditions are met
• grants received before the revenue recognition criteria are satisfied are recognised as a liability

Whether the accruals model or the performance model is adopted in overall terms the differences, if there are any, are limited to timing differences on recognition.

14.1 Tax treatment

For tax purposes grants which meet revenue expenditure, such as interest payable, are normally trading receipts, and this will continue where section 24 of FRS 102 applies.

15. Borrowing costs

FRS 102 section 25 and FRS 15 on capitalising borrowing costs are similar - both permit such treatment where relevant criteria are met.

15.1 Tax treatment

For those within the charge to Income Tax capitalised borrowing costs wouldn’t be allowable as a tax deduction. Tax legislation at section 29 ITTOIA says that, for calculating the profits of a trade, interest is always a revenue (as opposed to capital) item.

Section 58 ITTOIA allows relief for certain incidental costs of obtaining finance which has been incurred wholly and exclusively for the purpose of obtaining the finance, providing security for it or repaying it.

16. Share based payments

Accounting for share based payments under Old UK GAAP (FRS 20) and FRS 102 (section 26) are aligned with few differences.

16.1 Tax treatment

Businesses within the charge to Income Tax won’t generally have shares but, for companies within the charge to Income Tax, tax deductions are governed by specific legislation at section 94A ITTOIA.

17. Employee benefits

17.1 Pension schemes

In respect of accounting for pension schemes section 28 of FRS 102 differs to FRS 17 in particular:

• it removes the multi-employer exemption on defined benefit schemes such that the scheme position is reported in the solus accounts of the entity contractually or legally responsible for the plan
• the calculation of the net interest on defined benefit schemes is different. Under section 28 of FRS 102 the net interest comprises the expected interest income on plan assets, the interest cost on the scheme obligation and interest on the effect of the asset ceiling (should one be present)

These changes, and others, are not expected to have an impact for tax. Under current UK tax law, sections 196 and 246 FA 2004 and sections 38 to 44 ITTOIA provide for relief on a contributions paid basis.

17.2 Holiday pay accrual

Under Old UK GAAP many entities did not accrue or provide for holiday pay. FRS 102 requires that when an employee has rendered services to an entity during a period any related holiday pay or similar is accrued for. For tax purposes this accrual would be treated in line with the treatment of unpaid remuneration which is dealt with at sections 36 to 37 ITTOIA.

17.3 Employee benefit trusts

Under Old UK GAAP, UITF 32 provides guidance on how to account for Employee benefit trusts.

The requirements of FRS 102 (section 9) are comparable. FRS 102 states that there is a rebuttable presumption that contributions to an intermediate payment arrangement where the employer is a sponsoring entity are made in exchange for another asset and don’t represent an immediate expense.

In addition the assets and liabilities of the intermediary will be accounted for by the sponsoring entity as an extension of its own business.

The above treatment doesn’t apply where it can be demonstrated that the sponsoring entity won’t obtain future economic benefit from the amounts transferred or it doesn’t have control of the right or other access to the future economic benefit.

17.4 Tax treatment

For tax purposes the treatment of employee benefit contributions is dealt with at sections 38 to 44 ITTOIA. Generally a deduction is deferred until employment taxes are paid on the employee benefits.

18. Foreign currency translation

Under Old UK GAAP a business would account for its currency exchange transactions in line with either SSAP 20 (where FRS 26 isn’t applied) or FRS 23 (where FRS 26 is applied). For businesses which have adopted FRS 23 (and FRS 26) the transition to FRS 102 and section 30 isn’t expected to result in any significant changes. For businesses that applied SSAP 20 many won’t encounter differences but when they do they may be significant. Four main areas of difference are set out below.

18.1 Tax treatment

A trader or property business may hold foreign currency in a bank current account, a deposit or investment account or, more rarely, in notes or coins. Exchange differences that arise to unincorporated traders on such assets will be within the charge to tax on trade or property business profits if the holding of the foreign currency is an integral part of the trade. If the trader holds a foreign currency asset for investment or speculation, exchange gains and losses won’t be trading income or expenses.

18.2 Matching

If a business has monetary assets and monetary liabilities in the same foreign currency that are matched, nothing is taken to the profit and loss account for the exchange differences. However normally there will be an excess of assets over liabilities, or vice versa, which results in a residual exchange difference. It will be necessary to determine how much of the residual exchange difference is revenue and how much is capital as only revenue amounts are taken into account for Income Tax purposes. For more guidance see HMRC’s Business Income Manual at BIM39555 and BIM39560.

18.3 Functional or presentational currency

Determination of functional currency under FRS 102 requires consideration of the currency of the primary economic environment in which the entity operates. Key factors in determining this are the currency that mainly influences the sales prices for goods and services and the currency of the country whose competitive forces and regulations mainly determine the sales prices of its goods and services. Consideration is also given to the currency in which funds from financing activities are generated and the currency in which receipts from operating activities are usually retained. This is in line with the accounting adopted by entities which currently apply SSAP 20.

It may be that when these factors are taken into account this will result in a different assessment of the entity’s functional currency. This could have a significant impact on the calculation of the profits recognised in the accounts. In particular, this can create exchange rate volatility where the entity’s assets and liabilities are denominated in a different currency to that of its functional currency.

In addition, FRS 102 allows an entity to have a ‘presentation currency’ which isn’t necessarily the same as the functional currency. This typically has less impact on the calculation of the entity’s profit for a period (just that it’s expressed and presented in a different currency).

18.4 Foreign operations (including branches)

Income and expenditure of foreign operations (including branches) are translated into the business’s functional currency at actual or average rates not at closing.

18.5 Contract rate accounting

Where a business enters into a contract to settle a transaction at a particular rate of exchange, SSAP 20 stated that the exchange rate fixed by the contract may be used to record the transaction.

The position is different under FRS 102. The use of a contracted rate of exchange to translate monetary items isn’t permitted. The closing rate as at the balance sheet date should be used instead. The contract would typically represent a derivative financial instrument which would then be separately recognised and measured at fair value in the accounts.

This is a further example of a hedging relationship where under FRS 102 the hedged item and the hedging instrument need to be recognised separately in the accounts.

The accountancy and tax treatment of hedging relationships is discussed above see section 5.13.

Transitional adjustments may also arise - see part B for more information.

18.6 Net investment hedging (also known as the ‘Cover method’ or ‘SSAP 20 matching’)

Where an equity investment denominated in a foreign currency is hedged by a loan, SSAP 20 allows a business to re-translate the investment at the balance sheet date as if it were a monetary item. Exchange differences on the shares are taken to reserves. Exchange differences on the hedging loan are also taken to reserves, and offset against the gain or loss on the shares. Any excess on the loan that can’t be offset is taken to profit and loss account. This method of accounting is sometimes called the ‘cover method’ or ‘net investment hedging’. Although it may be unusual for an individual to use net investment hedging for a trade, it may be present where there is an investment in a branch, partnership or other tax transparent entity.

There is no equivalent in section 30 of FRS 102 for the ‘cover method’ of hedging non-monetary assets. Hedge accounting is instead dealt with by Section 12 of FRS 102 (or IAS 39 where this option is taken) - see section 5.13.

18.7 Tax Treatment

For Income Tax there is no equivalent to regulations 3 and 4 of the Disregard Regulations (SI 2004/3256) under which the exchange gain or loss on the loan or derivative would be ‘disregarded’ for tax. However, gains or losses will generally relate to capital items and, if so, won’t be taken into account for Income Tax purposes.

Further information on whether an item is of a capital or revenue nature can be found under ’Tax treatment’ see section 5.6.

19. Liabilities and Equity

Accounts prepared in accordance with Old UK GAAP will apply the presentation and disclosure requirements of FRS 25 for financial instruments and in particular liabilities and equity.

FRS 102 contains comparable requirements in section 22, ‘Liabilities and Equity’. Consequently on transition from Old UK GAAP to FRS 102 no changes are expected for the classification or presentation of liabilities and equity that currently fall within the scope of FRS 25.

However, while the classification and presentation may not change, the subsequent measurement of such items may change on adoption of FRS 102. For example the accounting on issue of a compound financial instrument is comparable across Old UK GAAP (FRS 25) and FRS 102 (section 22). In all cases the issuer will be required to account for the debt and the equity components separately. For more guidance see HMRC’s Corporate Finance Manual at CFM21260. However, the issuer of such an instrument will need to consider the measurement requirements of section 11 and 12 (or IAS 39) for subsequent measurement of the debt component - see section 5.

20. Specialised activities

FRS 102 section 34 includes specific guidance on a number of specialised activities such as service concession arrangements, agriculture and extractive industries. Such specialised activities are not addressed within this paper.

21. Part B transitional adjustments (Old UK GAAP to FRS 102)

This part of the paper provides a summary of the key accounting and tax considerations that arise on transition from Old UK GAAP to FRS 102.

21.1 Accounting

In accounting terms transition to FRS 102 is addressed in section 35 of FRS 102.

On transition FRS 102 section 35 requires that the balance sheet presented for the accounting transition date:

• recognises all assets and liabilities whose recognition is required by FRS 102
• doesn’t recognise assets and liabilities if FRS 102 doesn’t permit such recognition
• reclassifies assets, liabilities and components of equity to make sure presentation is consistent with FRS 102
• measures all recognised assets and liabilities in accordance with FRS 102

The transition date, for accounting purposes, is the first day of the earliest accounting period presented in the accounts. For example for entities preparing their accounts at 31 December 2015 the transition date will be 1 January 2014.

FRS 102 contains certain transitional exceptions and exemptions to the above requirements. These are not repeated here in detail but cover areas such as business combinations, estimates, intangibles, investment property and service concession arrangements.

However, even with such exceptions and exemptions it’s expected that on transition there may be a significant number of adjustments both to the carrying value of assets and liabilities recognised previously under Old UK GAAP and in terms of newly recognised assets and liabilities. For accounting purposes these adjustments will be made to the assets and liabilities as at the accounting transition date with a corresponding adjustment made directly to the opening profit and loss reserves.

For trading profit Chapter 17 Part 2 ITTOIA provides that where there is a change from one valid basis on which the profits of a trade are calculated to another valid basis. For example on a change of accounting policy, an adjustment must be calculated to make sure that business receipts will be taxed once and once only, and deductions will be given once and once only. For Income Tax purposes, an adjustment resulting in a profit is subject to a standalone tax charge as ‘adjustment income’ and a negative adjustment is treated as an allowable deduction in computing the profits of the trade. Details of the calculation are set out in HMRC’s Business Income Manual at BIM34130.

21.2 Trades and Property Businesses

The relevant legislation for Income Tax is in Chapter 17 Part 2 ITTOIA. Section 227(4) reads. A ‘change of accounting policy’ includes, in particular a change from using:

• UK GAAP to using GAAP with respect to accounts prepared in accordance with international accounting standards
• GAAP with respect to accounts prepared in accordance with international accounting standards to using UK GAAP.

So while it details UK GAAP to IAS and vice versa, the key phrase is that a ‘change of accounting policy includes in particular’ those 2 cases. While the change from Old UK GAAP to New UK GAAP isn’t listed, it’s still included within the scope of this provision.

For property businesses within the charge to Income Tax, Chapter 7 Part 3 ITTOIA deals with adjustment income and expenses where the basis on which the profits are calculated changes.