FRS 102 to have less restrictive requirements for “basic financial instruments”

Thu 07 Aug 2014

The Financial Reporting Council (FRC) have announced that they will implement FRED 54 to amend section 11 of FRS 102, the new UK GAAP framework.  The amendments will take effect for financial years ending on or after 1 January 2015, simultaneous with FRS 102 becoming effective.

The tax relevance of this change flows from the default rule for the taxation of profits or losses from loan relationships that the profits or losses as included in GAAP compliant accounts are followed for tax (see CTA 2009 s 313).

FRS 102 sets out a prescriptive list of criteria that financial instruments (FI) have to meet to be basic FI.  However the amendments to FRS 102 will make the tests less restrictive and should:

1. Allow a wider range of debt instruments to be measured at amortised cost
2. Align the measurement requirements for FI more closely with those of IFRS 9 ‘Financial Instruments’
3. Reduce the cost of compliance with FRS 102.

The expanded variety of FI that may be classified as basic is evident from the amended slimmed down section 11.11 of FRS 102.  A new Appendix to section 11 with examples of FI gives explanations as to whether each meets, or does not meet, the conditions to be basic FI. The six examples are:

• A zero-coupon loan
• A fixed interest rate loan with an initial tie-in period which reverts to the bank’s standard variable interest rate after the tie-in period
• A loan with interest payable at the bank’s standard variable rate less 1% throughout the life of the loan, with the condition that the interest rate can never fall below 2%
• Interest on a loan is referenced to 2 times the bank’s standard variable rate
• Interest on a loan is charged at 10% less 6-month LIBOR over the life of the loan
• Interest on a GBP denominated mortgage is linked to the UK Land Registry House Price Index (HPI) plus 3%

For a marked up copy of section 11 of FRS 102 and the new appendix to section 11 see FRED 54.

One of the more complicated areas in FRS 102 is the treatment of FI.  The amendments will reduce the number of companies that will have to fair value certain FI.