Consultation on FRED 82 ended in April. Its proposed changes to FRS 102 are likely to have a significant impact on brokers. Satya Beekarry, Partner in our Financial Services team, says that brokers should start planning now.
FRED who?
The Financial Reporting Council (FRC) issues FREDs (Financial Reporting Exposure Drafts) on a periodic basis and at least every five years. FREDs are a way for the FRC to seek feedback on proposed changes to Financial Reporting Standards in the UK and Republic of Ireland (FRSs). Once a FRED has been issued, the FRC typically holds a consultation period during which interested parties can send their comments. The FRC then considers these comments before finalising the proposed changes.
FRED 82 was issued in December 2022 following only the second periodic review of FRS 102 and the comment period ended in April 2023. It proposes several changes to FRS 102 to broadly align it with IFRS. The proposed effective date of the changes is 1 January 2025.
What are the key proposed changes?
In summary, the amendments most likely to affect brokers are:
- Revenue recognition (Section 23 of FRS 102): The new five steps model for revenue recognition will be broadly aligned with IFRS 15, but with some simplifications. The five steps of IFRS 15 are:
- Identify the contracts with a customer
- Identify the performance obligations in the contract
- Determine the transaction price
- Allocate the transaction price to the performance obligations
- Recognise revenue when each performance obligation is satisfied.
- Lease accounting (Section 20 of FRS 102): The new lease accounting model will be broadly aligned with IFRS 16, but with some simplifications. It will require almost all leases to be brought onto the balance sheet from the lessee’s perspective. It requires the recognition of a right-of-use asset and a lease liability for all leases with a term of more than 12 months, unless the underlying asset is of low value.
- Other changes: FRED 82 also proposes a number of other changes, mostly seeking alignment with IFRS, including the adoption of the IFRS 13 definition of fair value, guidance on factors to consider when accounting for uncertain income tax positions, share-based payments and business combinations.
Wide reaching commercial impact
In short, judging by the challenges that IFRS preparers faced with IFRS 15 (Revenue) and IFRS 16, FRED 82 is likely to have a significant impact on brokers. The commercial impact of these changes could be wide reaching for the broking industry.
Revenue recognition
It is important to review all major customer contracts in detail to understand the potential impact. The new revenue standard has requirements for identifying distinct performance obligations. Brokers need to consider the various services that they provide, make an allocation to performance obligations based on the relative stand-alone selling prices, and analyse potential patterns of revenue recognition. Entities might need to exercise judgement as to what constitutes a ‘distinct’ performance obligation and the period/pattern over which a customer receives the benefits of these distinct services.
The timing of revenue recognition for your business is also likely to be impacted. Revenue from placement income and claims management are likely to be impacted. Arrangements that feature contingencies and trail commissions require particular consideration. This is because the new revenue standard will require entities to recognise revenue when a performance obligation is satisfied, even if the amount of revenue is uncertain.
- Some entities might be able to recognise revenue earlier. However, if the amount of revenue is highly susceptible to factors outside the entity’s influence, revenue recognition might be constrained. This might be the case with contingent profit commissions which vary with a carrier’s claims experience. At the start of such contracts, the entity might need to constrain revenue recognised and over time as revenue becomes less susceptible to variation, the entity is able to recognise more revenue.
- The revenue standard might also lead to earlier recognition of revenue than current UK GAAP with regards to certain types of renewal commissions (‘trail commissions’) where the broker has no additional responsibilities to secure contract renewals or to perform any other activities under the contract. In this case recognising revenue at initial contract inception, including commissions relating to expected future renewals might be appropriate.
- The impact of the constraint on variable consideration might be affected by whether it is assessed for an individual contract or for a portfolio. It might be difficult to prove that the revenue for trail commissions upon renewal of an individual policy is highly probable of not being subject to significant reversal but the entity might be able to assess the constraint at the portfolio level instead.
- In many commercial lines of business, the broker might be performing ongoing services (e.g. claims management and customer care) in addition to the original placement. In these instances, recognition of the entire amount of commissions, including any renewal commissions, at initial placement would be inappropriate.
Leases
The new lease accounting model will require most leases to be brought onto the balance sheet. This could have a significant impact on financial statements and key ratios, as it will increase lease liabilities and right of use assets on the balance sheet while also increasing finance expenses and depreciation of the right of use assets and decreasing the operating lease rentals in the income statement.
The IFRS 16 definition of what constitutes a lease might also mean that new contracts are identified as leases that were not previously accounted for as such. For example, in group scenarios, consideration on which entity has the right of use of an asset could result in new leases and sub-leases being identified resulting in more complexity.
Other consequences
These changes could affect your profit margins, reward schemes, ability to meet financial covenants and pay dividends. So, it is important to understand the changes that are proposed and to start planning for the transition now.
What are commenters saying?
Most commenters have been broadly supportive of the proposed changes. This is partly because the FRC, to their credit, began the review process early in March 2021 with request for views and considered the views of stakeholders in drafting FRED 82. Most of the amendments are likely to be finalised as proposed, including those with regards to Sections 20 (leases) and 23 (revenue).
However, not everyone is happy with certain aspects of the proposals. For example, some believe that extending the requirements of IFRS 15 to micro-entities (FRS 105) is not commensurate. Commenters have also expressed concerns that the proposed effective date of 1 January 2025 provides a very short lead time for preparers. For context, the effective date of IFRS 15, initially issued in 2014, had to be deferred to 1 January 2018 to allow preparers sufficient time for transition.
What other amendments is the FRC working on?
The FRC most recently issued FRED 83 in April 2023 which proposes amendments to FRS 102 and FRS 101 to introduce a temporary exception to the accounting for deferred taxes arising from the implementation of the Pillar Two model rules, alongside targeted disclosure requirements. The OECD’s Pillar Two model rules introduce a global system of interlocking top-up taxes that aim to ensure that large multinational groups pay a minimum amount of income tax.
The FRED 83 proposed amendments are like those issued by the IASB for IFRS reporters in May 2023. We expect FRED 83 to be uncontroversial in the UK as it has broad support as shown by the rapid finalisation of the corresponding IAS 12 (IFRS) amendment by the IASB. The comment period for FRED 83 was accordingly much shorter and ended in May 2023 and we expect the amendments to be finalised by the FRC this Summer.
Can we help?
Absolutely! Our experienced accounting advisory team can help you with impact assessment, implementation and transition to the amended FRS 102 standards. We have a team of enthusiastic and experienced individuals who have previously worked on IFRS 15, IFRS 16 and IFRS 17 transitions and understand the challenges these accounting changes pose to preparers. Please do not hesitate to contact us to discuss further.
