Time to think about the impact of new UK GAAP on Treasury
11 October 2013
Companies that currently adopt UK GAAP, including those that have adopted FRS 26, need to be thinking about the implications and their choices available for the standards that will replace current UK GAAP.
From a Treasurer’s perspective, early analysis of the financial instrument implications will be essential to:
- Understand the consequences of conversion on key ratios, reserves, covenants, distributable profits, systems, cashflows etc;
- Balance the benefit of reduced disclosure choices against future listing requirements;
- Allow time to do something differently;
- Consider the tax implications;
- Make certain elections related to hedging, derivatives and/or functional currency; and
- Ensure suitable hedging documentation is in place by the accounting transition date.
In my discussions to date a few issues have cropped up that I believe Treasurers should be alert to:
- FRS 102 and IFRS both use the concept of functional currency not local currency. The functional currency of many treasury companies, holding companies and SPEs will change, particularly if the company is not seen as autonomous from the parent. This may cause foreign exchange volatility in the income statement impacting taxation, distributable profits and covenant compliance.
- SSAP 20 net investment hedging will not be allowed under FRS 102 or IFRS Specific consideration of foreign currency loans (both internal and external) is important to ensure that these do not trigger the foreign exchange volatility issues described above. In particular FX hedging strategies that work from a group perspective will need to be re-evaluated to ensure that the entity accounting treatment remains acceptable.
- More financial instruments will be recorded at fair value – including derivatives and certain instruments containing terms that lead to cashflow volatility (effectively embedded derivatives). IFRS requires embedded derivatives to be separated. FRS 102 requires the whole instrument to be measured at fair value. Identifying all embedded derivatives/unusual terms may take some time and may be difficult to value. In addition the accounting for debt instruments that don’t pay interest, or have off market terms, may prove a particular challenge with unexpected consequences.
- Hedge accounting requirements will change. FRS 102 has a limited list of permitted hedges and, as derivatives must be recorded at fair value, there will be more P&L volatility if you don't hedge account. The FRC are currently planning to bring FRS 102 more in line with the new IFRS 9 hedging proposals but, under both current FRS 102 and the proposed changes, hedges will need to be documented in advance and expected to be highly effective. The transition date is 1 January 2014 so, if Treasurers want to achieve hedge accounting in the first year of adoption as well as in the comparative period, the hedges need to be documented appropriately as well as any tax elections.
- The transition date is only a few months away. Just because the timeline for implementing changes to IFRS financial instruments accounting keeps slipping, the timeline for the removal of old UK GAAP will not change. All entities who currently prepare UK GAAP statutory accounts will have to convert to a new GAAP, be that new UK GAAP (FRS 102), full IFRS or IFRS with reduced disclosures (FRS 101) by periods beginning on or after 1 January 2015 at the latest.
There are plenty of other non-financial instrument changes too, but the points above are likely to take significant resources (time, people and systems) to resolve so Treasurers need to ensure that their organisations have a clear transition strategy and plan that also includes the treasury and tax consequences.