Service businesses: The impact of FRS 102
Accounting for sales (revenue)
Current accounting standards require you to recognise sales as you earn the right to be paid for your contractual performance. In particular, when a service contract is performed over a period of time, revenue is recognised on a ‘percentage of completion’ basis - either as time is spent on the contract or as value is provided to the customer.
FRS 102 does not change the basic approach to accounting for sales. However it provides several brief examples that may relate to your business model, including:
- subscriptions to publications;
- customer loyalty schemes;
- installation fees;
- servicing fees;
- advertising commissions;
- insurance agency commissions;
- financial services fees;
- admission fees;
- tuition fees;
- initiation, entrance and membership fees; and
- licence fees and royalties.
Revaluation of property
Currently you can opt to hold property at cost less depreciation (NB land is usually not depreciated) or at revaluation on your balance sheet. FRS 102 is broadly similar in this respect. If you have opted for revaluation, the new standard is less explicit on how often revaluations should be performed and by who.
If your property (including land) is worth more than its current carrying value in the accounts, FRS 102 allows a one-off revaluation to fair value on adoption of the standard. This figure is then ‘deemed’ to be the property’s cost for accounting purposes. You should consider whether this option would be beneficial, as it strengthens the balance sheet value of the company although may lead to lower future profits due to higher depreciation charges.
Treatment of loans
If you have financed the acquisition of properties (or any other plant and equipment) with bank or other loans, the accounting for these may change under FRS 102 as follows:
- Simple, commercial loans (e.g. with a single fixed or variable rate) will be measured at amortised cost. This means that an effective rate of interest will be applied to the outstanding capital at each year-end in arriving at the interest charged to profits. This charge may or may not equate to any actual interest you have paid.
- More complex commercial loan arrangements (e.g. capped or collared interest rates, or where an interest swap contract is in force) will mean accounting for the fair value of the loan at each year-end. If you have such arrangements, please talk to us so that we can help you to obtain the information you will need for your accounts.
- Non-commercial loans e.g. directors’, shareholders’ or group loans will need to be reflected at the value of future cash flows (in today’s terms - £1m today is worth more than £1m receivable in ten years’ time, for example). Again if you have such arrangements, please let us know so we can help you to account for these correctly.
Lease incentives and disclosure
If you receive incentives from landlords on rented properties, such as rent-free periods or cashback deals, the income for these is currently spread over the shorter of the lease term or the period to the first ‘break point’ in the lease. Under FRS 102 the incentives will be spread over the lease term.
This change in accounting treatment will decrease annual profits as less incentive is credited per annum, and will lead to tax cashflow advantages as a result.
As a lessee, you will need to disclose more in your accounts about your lease arrangements than under previous standards. This includes the total of all committed lease payments in today’s terms (split between amounts due in 1, 2-5 and over 5 years).
If you grow through acquiring other businesses, you currently recognise any difference between the purchase price and the fair value of the individual net assets you have acquired as ‘goodwill’. In future, you will need to consider whether there are other intangible assets (such as contracts with customers or brands) that should be separately recognised in your accounts before arriving at the goodwill figure. This can be complex to do, and we would be happy to advise further on this process. You will not need to revisit any previous acquisitions made before the date of transition to FRS 102 (which is broadly two years before the first year-end for which FRS 102 is adopted).
The goodwill and intangible assets will be written off, or ‘amortised’, over a useful life period of several years. You will need to decide on the appropriate useful life for each asset. In the rare event that this is not possible, the asset will be limited to a life of ten years.
If your holiday year and accounting year are not the same, then you should make an accounting adjustment each year for staff holiday earned but not yet taken. This was not explicitly required in the past but is now under FRS 102.
How we can help
We want to ensure that you are prepared and informed about the impact of FRS 102, which includes (but is not limited to) the issues we have covered above. If you would like to arrange an initial meeting where we can begin to plan for the specific impact on your business, please contact Martin Wharin, Business Services Partner on 0114 251 8850 or email@example.com.