Storyboard for

1. Financial instruments – Introduction to FRS 102 and transition issues Storyboard for

2. …clear thinking

3. By completing this module you will be able to: List the key differences between FRS 102 and existing UK GAAP Explain how FRS 102 will affect your company Apply the relevant recognition and measurement principles and disclosure requirements Make an action plan for what you need to do now At the end, you can visit useful Internet sites on a “Web Ride” Lecturer: Paul Gee  Learning time: approx. 20 min How to use this learning module? - Click on "Help" in the Table of Contents (TOC) Financial instruments – Introduction to FRS 102 and transition issues Graphic: [presenter or standard graphic]

4. The new UK GAAP currently comprises three standards: FRS 100, Application of Financial Reporting Requirements FRS 101, Reduced Disclosure Framework FRS 102, The Financial Reporting Standard applicable in the UK and Republic of Ireland FRS 102 will eventually replace all existing SSAPs, FRSs, and UITF Abstracts FRS 102 comprises 35 Sections, each dealing with a separate financial statement topic What is the new UK GAAP? Graphic: [CCH book on UK GAAP]

5. The FRS becomes mandatory for accounting periods commencing on or after 1 Jan 2015, although it may be adopted earlier for years ending on or after 31 Dec 2012 For a company with a 31 Dec year end, the first year for which FRS 102 becomes mandatory is 31 Dec 2015 There are special rules for transition to FRS 102, but the basic requirement is for retrospective application for the above company the 2014 comparatives must be restated according to requirements of FRS 102 When does FRS 102 come into effect? Graphic: [calendar]

6. Section 11 deals with basic financial instruments Section 12 deals with other financial instruments issues (effectively those relating to more complex financial instruments) Section 22 deals with liabilities and equity (this is not referred to in this module) Section 35 deals with the transition from existing UK GAAP to FRS 102 …and don’t forget that Schedule 1 of the Regulations to Companies Act 2006 still apply (including Section D on Fair value accounting) FRS 102 and financial instruments Graphic: [CCH book on FRS102/ Cover of FRS 102]

7. These are listed in Section 11 - for most entities the list will mainly consist of: Cash at bank (current or deposit) Bank loans and overdrafts Trade debtors Trade creditors Investments in equity shares Loans to related parties Loans from related parties What are basic financial instruments? Graphic: [a debtors ledger screen/ print out]

8. Financial assets and financial liabilities are usually recognised initially at the undiscounted transaction price, including any transaction costs for trade debtors, trade creditors and bank balances, this means face value Where the arrangement effectively constitutes a financing transaction, the financial asset or liability should be measured at the present value of the future payments discounted at a market rate of interest for a similar debt instrument an example might be goods sold to customers on 2 years interest-free credit Basic financial instruments: other than investments – initial recognition and measurement Graphic: [a sofa]

9. Investments in shares are classified as ‘basic financial instruments’ provided they are not redeemable or convertible into other shares If the shares are publicly-traded or their fair value can otherwise be measured reliably, the investment is measured and recorded initially at fair value (purchase cost exclusive of transaction costs) If fair value cannot be measured reliably, the investment is measured and recorded initially at cost, inclusive of transaction costs Basic financial instruments: investments – initial recognition and measurement Graphic: [abacus]

10. Debt instruments will generally be measured at amortised cost using the effective interest method – see screens below Trade debtors will have to be assessed for impairment, but otherwise the only adjustment required will be for amounts received Trade creditors and bank overdrafts will be accounted for as at present Certain complex debt instruments referred to in para 1.11 of Section 11 must be dealt with according to Section 12 of FRS 102 – these are outside the scope of this module Basic financial instruments – subsequent measurement Graphic: [calculator]

11. Investments in shares which are publicly-traded or whose fair value can otherwise be measured reliably measure at fair value, with changes in fair value recognised in profit or loss Investments in shares whose fair value cannot be measured reliably continue to record at cost, subject to assessment for impairment Basic financial instruments – subsequent measurement (cont) Graphic: [a copy of the Financial Times]

12. The amortised cost of a financial asset or financial liability at each reporting date is the net of the following amounts: the amount at which the financial asset or financial liability is measured at initial recognition minus any repayments of principal plus or minus cumulative amortisation of any difference between the amount at initial recognition and the maturity amount minus (for a financial asset) any reduction for impairment or uncollectibility Amortised cost using the effective interest method Graphic: [a set of greengrocers scales]

13. On 1 Jan 20x1 a company borrows £1,000 incurring transaction costs of £50 – so net proceeds received amounts to £950 Interest of £40 is payable annually for a period of 5 years at the end of each year The loan is repaid at £1,100 (i.e. at a premium of £100) on 31 Dec 20x1 The effective rate of interest is determined by computer program at 6.9583% - this is the rate that discounts the expected cash flow on the loan to the initial carrying amount of £950 This is summarised in the table on the following screen The total interest expense of £350 comprises interestpayments £200+ transaction costs £50 + premium on repayment £100 Example: Amortised cost using the effective interest method

14. Example: Amortised cost using the effective interest method (cont)

15. At the end of each reporting period, an entity is required to assess whether there is objective evidence of impairment of any financial assets that are measured at either cost or amortised cost: financial assets measured at cost included investments in shares where fair value cannot be measured reliably financial assets measured at amortised cost include loans receivable and trade debtors Para 11.22 of Section 11 gives examples of objective evidence – these relate to observable data which comes to the attention of the holder of the financial asset Impairment of financial instruments measured at cost or amortised cost Graphic: [MOT sign]

16. The disclosure requirements in Section 11 are fairly detailed and cover just under three pages These are summarised on pages 7 to 9 in the notes Don’t forget the disclosure requirements in Schedule 1 of the Regulations to Companies Act 2006 Basic financial instruments - disclosures Graphic: [a disclosure checklist]

17. FRS 26 and FRS 29 deal with recognition, measurement and disclosure, but are only mandatory for restricted categories of companies an example would a listed parent company that adopted UK in its individual financial statements It appears that relatively few unlisted UK companies have chosen to adopt FRS 26 and FRS 29 on a voluntary basis so for most companies FRS 102 will introduce several changes The impact of FRS 102 is likely to vary significantly as between different entities How do these requirements differ from existing UK GAAP? Graphic: [map of UK]

18. Entities that have fairly basic financial instruments and who do not have investments in equity shares may find that there is little impact on the balance sheet and profit and loss account Entities that have investments in equity shares or derivatives such as forward foreign currency contracts will have to consider the impact of fair value requirements for entities with 31 Dec year-ends, the issue of fair value may come around very soon: transition date of 1 Jan 2014 is not that far away! All entities will have to address the issue of extended disclosure requirements as compared with existing UK GAAP Which kinds of entities will FRS102 have most impact on? Graphic: [description of graphic]

19. Derivatives such as forward foreign currency contracts and interest rate swaps are not regarded as basic financial instruments and are outside the scope of Section 11 so only a brief mention will be made in this module Apart from relatively few entities who have adopted FRS 26 on a voluntary basis, these derivatives will not previously have been recognised in the balance sheet This is a major area of change under FRS 102 which requires them to be included in the balance sheet at fair value Changes in fair value will be recognised in profit or loss (except for entities who choose to adopt complex hedge accounting in Section 12) What about derivatives? Graphic: [Euro bank notes]

20. Yes – as a general point, entities will need to give careful consideration to the deferred tax requirements of Section 29 – be warned: this is a tricky section! This may be relevant to financial instruments as well as to revalued property, plant and equipment, and investment property Deferred tax may need to be provided where certain financial assets are included in the balance sheet at fair value as opposed to historical cost an example would be an investment in equity shares held at fair value Will deferred tax be an issue? Graphic: [HMRC logo]

21. For the sake of clarity, assume a company with a 31 Dec year end will adopt FRS 102 for the first time for its 31 Dec 2015 accounts The crucial date is transition date - in this case, 1 Jan 2014 The basic rule is that the company applies retrospective restatement, so the 2014 comparatives will be restated as though FRS 102 had been applied to them The detailed rules are set out in para 35.7 – and these are covered on the following slide as applied to the company referred to above How will the transition rules in Section 35 affect financial instruments? Graphic: [Autumn tree with leaves turning from green to brown ]

22. Recognise all assets and liabilities whose recognition is required by this FRS this will apply to items already in the balance sheet such as trade debtors and creditors and investments, as well as those that were not such as forward foreign exchange contracts Do not recognise items as assets or liabilities if this FRS does not permit such recognition this should not affect most UK companies, as it unlikely that items previously recognised on the balance sheet can no longer be recognised under FRS 102 The requirements of para 35.7 Graphic: [Lenin]

23. Reclassify items recognised under existing UK GAAP again, this is unlikely to affect most UK companies who are required to adopt FRS 25 Apply this FRS in measuring all recognised assets and liabilities this is a crucial requirement where items currently carried at historical cost are required to be carried at fair value (for example investments and derivatives) The requirements of para 35.7 (cont) Graphic: [Stalin]

24. A company has investments carried in balance sheet at 31 Dec 2013 at cost of £250,000 At transition date 1 Jan 2014 the company obtains a reliable fair value for the investment amounting to £330,000 The uplift to fair value of £80,000 will be presented as an adjustment to retained earnings at 1 Jan 2014 in the restated comparative financial statements (paragraph 35.8) A deferred tax provision will need to be set up in accordance with paragraph of 29.6 of Section 29 – the debit side of the entry will be offset against the adjustment to retained earnings of £80,000 Example: dealing with remeasurements at transition date

25. If your year-end is 31 Dec, the date of transition to FRS 102 is 1 Jan 2014 You will need to review carefully your balance sheet at 31 Dec 2013 as prepared under existing GAAP Identify all your financial instruments This includes those which were not required to be recognised on the balance sheet under existing UK GAAP Apply the recognition, measurement and disclosure requirements in Section 11 and 12 Some financial assets and liabilities previously recorded at historical cost may need to be re-assessed at fair value Study carefully the requirements and exemptions in Section 35 dealing with transition issues – reference is made to these later in this module but will be covered in greater detail in a further module later in the year Financial instruments: what do you need to do now? Graphic: [horses at the start of a race]

26. The key things to remember from this module are: Go carefully though your balance sheet, identifying all financial assets and financial liabilities and identifying any items whose carrying amount may need to be remeasured at fair value Ensure any off-balance sheet items such as derivatives have been identified Obtain fair value measurements where these are required – both at transition date and at comparative balance sheet date Review the new disclosure requirements to ensure that all required information will be available (in the first set of financial statements, extended disclosure requirements extend to comparatives) Summary Graphic: [standard summary graphic]

27. Web Ride

28. …clear thinking

29. Please select the correct answer(s) and then click on “Submit” Which of the following measurement methods for investments in unlisted equity shares is required by FRS 102? Cost Fair value – changes taken to equity not throughcomprehensive income Fair value – changes taken through profit or loss Fair value – changes taken through other comprehensive income Question 1

30. Please select the correct answer(s) and then click on “Submit” A company which will be adopting FRS 102 has a 31 Mar year-end.  Which of the following statements is correct? 1. The company may adopt FRS 102 for year ended 31 Mar 13 2.The company must adopt FRS 102 for year ended 31 Mar 14 at the latest 3.The company must adopt FRS 102 for year ended 31 Mar 15 at the latest 4.The company must adopt FRS 102 for year ended 31 Mar 16 at the latest. Question 2

31. Please select the correct answer(s) and then click on “Submit” A company has an unlisted investment previously held at cost, but for which a reliable fair value is available. Which of the following are permitted on transition to FRS 102? Adjust the carrying amount in the 2015 accounts only, putting fair value changes through profit or loss Adjust the carrying at transition date against retained reserves at that date, with any subsequent changes in fair value taken through profit or loss Adjust the carrying amount at transition date against retained reserves at that date, with any subsequent changes in fair value taken through other comprehensive income Leave the investment at cost as the company is unlisted Question 3

32. Now you have finished this module and acquired basic knowledge on financial instruments If you answered all the questions in the Quiz correctly, you can print out your personal certificate by clicking on the link Thank you for your attention! Finish Graphic: [standard finish graphic]