Property and the new accounting standards
The new accounting standard FRS102 has been around for some time now and most medium and large companies to whom it applies will now have filed their first accounts under the new regime. For a lot of small companies, however, this is only just coming onto their radar as they look to address the issues and options it brings for the first time. Whilst we have covered some of this content in previous articles, here we briefly recap upon the property scenarios that arise.
Please note that these changes are applicable for accounting periods commencing on or after 1 January 2016 for small and micro companies.
In terms of carrying values small companies will still have to carry investment properties at a valuation at each balance sheet date when adopting FRS102, similar to old UK GAAP. This value now has to be “fair value” as opposed to “open market value” which, for most straightforward properties, will be the same figure.
The key points to note where the main changes lay are as follows;
- The valuation doesn’t specifically have to be carried out by a professional valuer, however bear in mind that if the directors provide a valuation it must be supported by corroborative evidence, especially where the small company is still audited, as the auditors will need to be able to substantiate that this is materially correct.
- Under the current version of FRS102 there is no longer a “group let” exemption in place. This means that where a group’s trading property(ies) are held outside of the trading company and are instead let to them by the parent or other group entity, these properties would be included as investment properties at a fair value in the standalone accounts of the owner. At a consolidated level they would then revert to being shown as trading properties of the group. (*)
- All gains or losses on the revaluation of investment properties go through the face of the profit and loss account, affecting the net profit or loss presented to the shareholders.
- The theoretical tax payable should you sell the properties at the revalued amount(s), referred to as deferred tax, also now has to be provided through the profit and loss account (note that no tax is payable to HMRC until the property is sold).
(*) Proposed changes to the standard (FRS102) mean that the previously available, and most would say common sense exemption is likely to be brought back in. This would then revert us to the position whereby the properties were treated as trading properties of the group and revaluation would not be mandatory. This is currently proposed for accounting periods commencing on or after 1 January 2019, though early adoption may be permitted. This is expected to be confirmed by the end of 2017.
Properties used for trading purposes
There has historically been the option to either account for these at historic cost less depreciation or at a revalued market value. Where companies have chosen to revalue they have then to be committed to periodic revaluations to keep these figures up to date.
Essentially the two options still remain under FRS102, other than market value becomes fair value (as referred to under investment properties above) and the subsequent revaluations are less prescriptive. I.e, there is no longer a requirement to have a formal valuation every 5 years and an interim one after 3. Again, however, it is important to point out that, similar to the valuation of investment properties, the value (or lack of change therein) would have to be substantiated, not only for the auditors but also to be able to declare as directors that the financial statements give a true and fair view.
As with investment property revaluations there is deferred tax to provide for on revalued trading properties, however both gains/losses and the associated deferred tax get dealt with outside of the profit and loss account. In both cases the “gain” made on such revaluations would not form part of distributable reserves.
Whilst these options are largely unchanged there is a one-off transitional provision which only applies the first time the accounts are prepared and filed under the new standard.
This allows the directors to opt to “freeze” any historic valuation up to the date of transition (usually twenty four months before the year end date for which these FRS102 accounts are prepared though there are further provisions for small companies allowing some flexibility here), OR obtain a valuation at transition and “freeze” this. Freezing the valuation effectively results in adopting this value as “deemed cost” going forward and accounting for it as you would for a property held at cost.
This is a very helpful provision if the company would benefit from being able to reflect its increase in asset value (and perhaps improved credit rating etc) without committing itself to further cost for future valuations, or for those stuck in a costly revaluation cycle that is no longer any benefit to them.
What about Micro Entities
(I hear you cry…)
Whilst all of the above will apply to small companies, if your company qualifies as a micro entity life can be much more straightforward. It is worth noting that being a micro entity doesn’t necessarily mean you are particularly “small”, especially for some investment properties companies. If (for two consecutive years) you meet 2 out of the following 3 criteria you would qualify as micro in most cases, unless you are the parent of a larger group:
- Less than £632,000 Turnover
- Less than £316,000 Net assets (Balance Sheet Total)
- Less than 10 employees
Micro entities can adopt an alternative accounting standard called FRS105. Under FRS105 all properties have to be carried based on a cost model as fair value accounting is not allowed. Deferred tax is also prohibited and both of these issues are therefore removed.
Micro entity accounting might therefore be a sensible option for those property companies who want to minimise the compliance burden of obtaining and accounting for property revaluations. It is worth noting that whilst this may be appropriate and beneficial for some, micro entity accounts disclose very little information and may in some cases have a negative impact on credit ratings and a company’s ability to raise finance. We would advise anybody considering this to seek advice on any wider implications of adopting FRS105 before proceeding.