Audit Update 2024:
Key technical developments and emerging changes

1. Amendments to FRS 102 and other FRSs

Amendments Published

On 27 March 2024, the FRC published amendments to FRS 102 and other FRSs, which include:

• A new model for revenue recognition in FRS 102 and FRS 105.
• A new model for lease accounting in FRS 102.
• Various incremental improvements and clarifications.

Revenue Recognition (FRS 102 and FRS 105)

Revenue recognition principles now align with IFRS 15, using a five-stage model based on ‘promises’:

1. Identify the contract(s) with a customer.
2. Identify the promises made in the contract.
3. Determine the transaction price.
4. Allocate the transaction price to the promises.
5. Recognise revenue when (or as) promises are satisfied.

Key changes include handling warranties as separate promises and measuring refund liabilities by the amount of consideration received but not expected to be entitled. Transition options include a modified retrospective approach or full retrospective approach, with specific practical expedients available.

Leases (FRS 102 Only)

Lease accounting aligns more closely with IFRS 16, bringing most leases on-balance sheet. Simplifications include:

• Using the lessee’s incremental borrowing rate or obtainable borrowing rate.
• Simplified lease modification accounting.
• Simplified variable lease payment recognition.

Entities must use a modified retrospective approach for transition, applying the cumulative effect at the start of the first period of adoption, with several practical expedients available.

Small Company Disclosures (FRS 102 Section 1A Only)

Disclosures encouraged for small companies under Appendix E of Section 1A will become mandatory. Additional disclosures are required for provisions, share-based payments, leases, revenue, and tax.

Other Changes (FRS 102 Only)

• Section 2 Concepts and Pervasive Principles updated based on the IASB’s 2018 Conceptual Framework.
• New Section 2A Fair Value Measurement, based on IFRS 13.
• Option to newly apply IAS 39 removed for new adopters.
• Transition to disclose material accounting policies rather than significant ones.
• Additional disclosures for business combinations and specific guidance on share-based payments and uncertain tax treatments.

Supplier Finance Arrangements

New disclosure requirements for supplier finance arrangements align with amendments to IAS 7 and IFRS 7. Entities must disclose terms, carrying amounts, payment due dates, and non-cash changes for such arrangements.

Effective Dates

• Principal effective date: accounting periods beginning on or after 1 January 2026, with early application allowed if all amendments are applied together.
• Supplier finance arrangement disclosures: effective for periods beginning on or after 1 January 2025, with early application permitted.

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2. FRED 85 – Draft amendments to FRS 101

Background

In December 2023, the FRC published FRED 85, proposing minor amendments to FRS 101 for greater consistency with IAS 1. The consultation period closed on 4 March 2024.

Proposed Changes

The proposed changes address specific scenarios and are not expected to be burdensome for FRS 101 financial statement preparers:

• Liability Classification: Mandate disclosures required by IAS 1 for non-current liabilities from loan arrangements subject to covenants within twelve months after the reporting period, allowing readers to understand the risk of repayment within that period.
• Supplier Finance Arrangements: Align with changes proposed in FRED 84 related to IAS 7 and IFRS 7. Since many entities preparing FRS 101 financial statements are qualifying entities eligible for disclosure exemptions, these changes will primarily affect financial institutions that do not qualify for such exemptions.

Recap of FRS 101

FRS 101 provides disclosure exemptions for individual financial statements of subsidiaries (including intermediate parents) that follow ‘adopted IFRS’ but use the “reduced disclosure framework.” It applies to qualifying entities that are part of a group where the parent prepares publicly available consolidated financial statements intended to give a true and fair view, including the qualifying entity in the consolidation.

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3. Revisions to the LLP SORP

Introduction

In May 2024, the Consultative Committee of Accountancy Bodies (CCAB) issued a revised LLP SORP. These changes mainly offer specific guidance rather than fundamental shifts, reflecting the proposed amendments from August 2023. The effective date is now for periods beginning on or after 1 July 2024, with early adoption permitted.

Climate-related Financial Disclosures

The updated SORP references the latest LLP Regulations requiring climate-related disclosures aligned with TCFD requirements. These apply to periods starting from 6 April 2022 for traded or banking LLPs with over 500 employees, or large LLPs with more than 500 employees and turnover over £500 million. Disclosures must be included in the strategic report or energy and carbon report.

Amounts Payable to Former Members

A clarification on share-based payments aligns with FRS 102 section 26. Though rare in LLPs, an example is given where a former member is entitled to a percentage of disposal proceeds upon the sale of an LLP’s business. The accounting treatment mirrors cash-settled payments, initially measuring the liability at fair value and recognising it either over the vesting period or fully at the grant date.

Sharing of Group Profits – Interests in Subsidiaries

Guidance has been added for recognising subsidiary members’ debt and equity interests in consolidated accounts:

• Equity Interest: Recognised as non-controlling interests.
• Debt Interest: Not recognised as non-controlling interests.

If members of the parent LLP also hold equity interests in the subsidiary, it should be assessed whether these are held on behalf of the parent LLP. Distributions from subsidiaries should be treated as income from group undertakings in the parent’s individual income statement.

Automatic Division of Profits to Non-Working Members

New guidance (Paragraph 34D) specifies that profits automatically allocated to members who contribute capital but provide no substantive services should be treated as a return on capital. This is relevant for LLPs where members have distinct roles, such as in property development LLPs.

Summary

The revisions to the LLP SORP issued by CCAB in May 2024 primarily provide specific guidance on climate-related financial disclosures, share-based payments to former members, the treatment of group profits and interests, and profit allocations to non-working members. These changes are expected to have minimal impact on the preparation of LLP financial statements.

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4. The Economic Crime and Corporate Transparency Act 2023

Background and Purpose

The Act was passed in late 2023 to enhance corporate transparency and combat economic crime.

Key Features

1. Companies House Reform
   • Strengthens the role of Companies House with increased powers to verify identities, reject inconsistent documents, and strike off companies registered under false pretences.
   • Abolishes the need for companies to maintain certain internal registers, requiring information to be provided directly to Companies House.
   • Identity verification for directors and document submitters will be mandatory, resulting in increased fees from May 2024.
2. Limited Partnerships
   • Tightens registration requirements and enhances transparency for limited partnerships, with more power given to Companies House for de-registration.
3. Small Companies – Accounting and Reporting
   • Small companies can no longer file abridged or filleted accounts and must file statutory profit and loss accounts and directors’ reports.
   • Micro companies must file profit and loss accounts but are not required to file directors’ reports. There is an option to keep these accounts private from the public record.
4. Failure to Prevent Fraud Offence
   • Introduces a strict liability offence for large organisations failing to prevent specified frauds by associated persons, with a global scope.
   • Organisations can defend against this by proving they had reasonable fraud prevention procedures in place.
5. Register of Overseas Entities
   • Aims to increase ownership transparency, with penalties for non-compliance, including restrictions on property sales and potential imprisonment.

Timescale

Some provisions took effect from 4 March 2024, with ongoing implementation as further statutory instruments are passed.

Initial Changes Effective from 4 March 2024

• Enhanced powers for Companies House, stricter checks on company names, new rules for registered office addresses, and mandatory registered email addresses for all companies.
• Ongoing data clean-up and sharing with other government departments and law enforcement.

The full details and wider proposals are still awaited, but these initial changes mark significant steps towards the Act’s goals.
You can find further details via our update here.

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5. FRC annual review of corporate reporting 2022/23

Top 10 findings

The Financial Reporting Council (FRC) published its annual review of corporate reporting for 2022/23, focusing primarily on larger and listed entities reporting under IFRS. The FRC found overall reporting quality to be satisfactory, maintaining levels from the previous year. However, persistent issues remain, particularly in ten key areas:

1. Impairment of Assets: Recurring issues include inadequate disclosures of assumptions and consistency in discount rates. Companies need to improve transparency and alignment with financial forecasts.
2. Judgements and Estimates: Disclosures often lack sufficient detail about estimation uncertainty. Significant judgements should be clearly explained with quantified sensitivities.
3. Statement of Cash Flows: Errors are common, particularly in prior year restatements. Cash flows should align with reported figures and meet classification criteria.
4. Strategic Report and Companies Act 2006 Matters: Many companies failed to provide comprehensive and balanced strategic reports, especially regarding economic risks and business impacts.
5. Financial Instruments: Issues include inadequate risk disclosures, improper offsetting of cash balances, and unclear accounting policies for financing arrangements.
6. Income Taxes: Challenges include reconciling effective tax rate items and supporting the recognition of deferred tax assets, especially under uncertain economic conditions.
7. Revenue: Improved familiarity with IFRS 15, but issues remain with variable consideration, agent vs principal judgements, and contract balances.
8. Provisions and Contingencies: Consistent application of inflation effects in measuring provisions and detailed disclosures of uncertainties are needed.
9. Presentation of Financial Statements: Frequent classification errors and insufficient disclosure of accounting policies.
10. Fair Value Measurements: Missing disclosures and insufficient explanation of valuation methods and assumptions. Companies should consider specialist advice for material valuations and include climate-related impacts where relevant.

The review suggests that while there is general satisfaction with reporting standards, there is room for improvement in these critical areas to enhance transparency and accuracy in financial reporting.

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6. Narrative Reporting

Directors’ Report

• Required for all companies except micro-companies.
• Small companies: Must include directors’ names, third-party indemnity provisions, political donations, details on disabled employees (if >250), directors’ responsibilities statement, auditor information, and small company exemption statement.
• Medium companies: Additional requirements include recommended dividends, financial instrument risk management, future developments, R&D details, and employee engagement (if >250 employees).
• Large companies: Must also include engagement with suppliers/customers, and carbon and energy reporting (with some exemptions).

Strategic Report

• Small companies: Exempt from preparing a strategic report.
• Medium companies: Must include a business review, principal risks, financial KPIs, and references to financial statements.
• Large companies: Also require non-financial KPIs and a section 172 statement.
• Additional TCFD disclosures are needed for very large companies and specific sectors.

Key Performance Indicators (KPIs)

• All non-small companies should include relevant KPIs in their strategic reports, covering financial (e.g., revenue growth, profit margins) and non-financial metrics (e.g., health & safety incidents, staff turnover).
• KPIs should be contextualised with narrative explanations.

Carbon and Energy Reporting

• Large companies must disclose carbon and energy usage, with exemptions for low usage or coverage by parent company reports.
• Disclosure is required where practical, including emissions, energy consumption, methodologies, intensity ratios, and measures to increase energy efficiency.

S.172(1) Statement

Large companies must include a statement in the strategic report detailing compliance with directors’ duties under s.172 of the Companies Act 2006, covering long-term consequences, employee interests, business relationships, community and environmental impact, high standards of conduct, and fair treatment of members.

Summary

Summary of reporting requirements:

	Basic directors’ report	Basic strategic report	Carbon reporting	S.172 statement	TCFD** reporting
Micro
Small	✔
Medium	✔	✔
Large	✔	✔	✔ *	✔
Very large	✔	✔	✔	✔	✔
* = Exemptions available
** TCFD = Task Force on Climate-related Financial Disclosures

Increasingly, stakeholders are becoming more interested in environmental, social and governance (ESG) considerations. By disclosing the way the company treat employees and the actions taken to reduce carbon emissions, the company may improve its public image. This can lead to improved recruitment or an improved relationship with customers, suppliers and the wider public.

ESG Introduction

• ESG (Environment, Social, Governance) impacts accounting significantly, requiring reliable non-financial information and assurance.
• Accountants play a crucial role in ESG reporting, integrating sustainability into risk management and reporting frameworks.
• ESG considerations affect supply chains and the firm’s own operations, influencing staff recruitment and client relations.

Overview of Reporting Frameworks

• Various voluntary and mandatory frameworks exist, with recent harmonisation efforts such as TCFD and IFRS S1 and S2 for climate-related disclosures.
• New EU standards (ESRS) apply from 2024, affecting large EU companies and some non-EU entities.
• Smaller business and organisations in the supply chain of in-scope businesses are likely to need to provide information to in-scope businesses for the purposes of reporting.

Double Materiality

• Whichever framework is used for reporting, the concept of double materiality will need to be considered.
• Reporting requires consideration of both impact and financial materiality, involving a broader range of stakeholders and sustainability issues relevant to the business.

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7. Summary of Accounting Estimates & Judgements

Background

• The FRC’s review highlights frequent inadequacies in accounting estimates and judgements.
• Common issues include insufficiently informative disclosures and inconsistencies in the provided information.
• Effective disclosures should describe significant judgements, include values and sensitivities for estimates, and be reassessed annually.
• FRS 102 and IAS 8 outline disclosure requirements for significant judgements and key estimation uncertainties.

Bad Practice

• Common issues include:
  • Lists without descriptions.
  • Irrelevant disclosures carried over from previous years.
  • Boilerplate disclosures lacking detail.
• FRC recommendations for improvement:
  • Clearly state the risk of material adjustments due to estimates.
  • Provide meaningful sensitivity disclosures.
  • Regularly reassess and update estimation uncertainty disclosures.
  • Clearly distinguish between significant short-term effects and other estimates.

Key Takeaways

• It is crucial to provide detailed and specific disclosures that offer a full picture to readers.
• Even small companies, despite having disclosure exemptions, must include additional necessary disclosures to ensure a true and fair view of the financial statements.

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8. Related parties

Background

Related party disclosures are often incomplete or omitted in financial statements.

Accounting Standard Definition

FRS 102 defines a related party:

• Individuals: Those with control, joint control, significant influence, or key management personnel roles.
• Entities: Those within the same group, associates, joint ventures, and others with similar connections.
• Close family members: Includes children, spouses/domestic partners, and dependants.

Key Points

• Individual Related Parties:
  • Significant shareholders (typically with at least 20% ownership).
  • Their immediate family and dependents.
  • Directors and key management, along with their immediate family and dependents.
• Entity Related Parties:
  • Parent and subsidiary entities.
  • Fellow subsidiaries.
  • Entities controlled or significantly influenced by the same individual.
  • Associates or joint ventures.

Disclosure Requirements

• For small entities (FRS 102 section 1A): Only material transactions not under normal market conditions need to be disclosed. Includes owners with a participating interest, entities where the small entity has a participating interest, and directors.
• For directors (Companies Act 2006): Additional disclosures required regardless of entity size.
  • Includes advances and credits granted to directors, main conditions, interest rates, amounts repaid, written off or waived.
  • Commitments entered into on behalf of directors, such as guarantees.

Practical Application

• Maintain a comprehensive list of related parties, updating it annually.
• Consider all transactions with related parties to determine the need for disclosure.
• Ensure compliance with both FRS 102 and Companies Act requirements, especially for director-related transactions.

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9. Dividends and other distributions

Background

Queries regarding distributable reserves and the legality of distributions are common.

Distributable Profits

• According to the Companies Act 2006, a company can only distribute profits that are accumulated and realised, minus any accumulated losses.
• Distributable reserves must be sufficient to cover the total dividend declared, even if some shareholders waive their rights to receive it.
• Keeping separate records for declared dividends (for future distribution) and paid dividends (for the balance sheet) is advisable.

Unrealised Profits

• Not all profits in the profit & loss reserve are distributable; profits must be realised.
• Realised profits typically occur when cash or qualifying assets are received, not from revaluations or fair value gains that are not converted to cash.
• Tracking unrealised profits is essential to ensure adequate distributable reserves for planned distributions.

Illegal Dividends

• Dividends paid without sufficient distributable reserves are considered illegal.
• Members who know or should reasonably know about the illegality must repay the distribution.
• Directors may also face liability for authorising illegal distributions.

Wrongful Trading and Unfair Prejudice

• Excessive dividend payouts can lead to a net liabilities position, exposing directors to wrongful trading charges under the Insolvency Act 1986.
• Conversely, a policy of not paying dividends can lead to claims of unfair prejudice from shareholders.

Conclusion

While there is no obligation to pay dividends, companies must ensure any distributions comply with distributable reserve limits and do not unfairly prejudice shareholders.

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10. Going concern

Background

The going concern concept has gained increased attention since the COVID-19 pandemic, leading to greater scrutiny from regulators and the public.

Role of Accountants

According to FRS 102 section 3.8, the assessment of going concern is the responsibility of the directors and management, but accountants can provide guidance and support, especially for clients who are unsure how to conduct the assessment. The assessment should cover at least 12 months from the financial statement approval date, considering significant events beyond that period.

Considerations for Assessment

Accountants should discuss various factors with clients, such as:

• Existing forecasts or budgets.
• Future business plans (contracts, acquisitions).
• Relevant post-year-end matters (financial difficulties, key contract renewals).
• Current cash balances and profitability.
• Dependency on specific customers or suppliers.
• External factors impacting the business.

Forecasts

While not mandatory, forecasts can aid in the going concern assessment. They should be based on reasonable methods and assumptions. Management must critically evaluate forecasts, particularly in terms of revenue growth expectations and cash balances. Auditors will review these forecasts, making it crucial for management to ensure their reasonableness.

Past vs. Future Performance

Past performance can inform future assessments but should not be relied upon solely. Established businesses can fail, as seen with companies like Wilko and BHS. Management should use historical data to validate future forecasts and avoid assuming stability based solely on past results.

Disclosures

FRS 102 mandates disclosure of the financial statement preparation basis if the going concern basis is not used. If it is used, any material uncertainties that may affect the entity’s ability to continue must also be disclosed.

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