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New accounting rules could have big impact on companies

Changes in accounting guidance are rarely a hot topic within the local businesses community, but the implementation of a new, single accounting standard (FRS102) to replace existing UK GAAP (Generally Accepted Accounting Practice in the UK), is proving to be an exception - particularly in the property and construction industry, given the nature of the assets and liabilities they hold.

The main concerns for construction companies are in connection with new rules for:

  1. the measurement of loans and financial instruments (including intra-group loans);
  2. loan covenant compliance;
  3. intra-group guarantees; and
  4. investment property valuations.

Loans and financial instruments will be classified as either basic or non-basic.

Whilst there is little change in how basic financial instruments, such as cash balances, trade debtors and creditors and typical bank loans will be recognised, non-basic financial instruments (typically more complex financing arrangements or non-commercial loans with terms and rates that fall outside normal market terms) are now recognised on the balance sheet at fair value, with year-on-year fluctuation taken through the profit and loss account, which is likely to generate greater volatility.

Unless the impact is considered in advance, this volatility may affect a company's compliance with banking covenants.

When changes in accounting standards potentially create this type of commercial difficulty, it is understandable that businesses are starting to take note of FRS102. When negotiating bank loans and associated covenants, the impact of FRS102 will be another important factor to consider.

Intra-group loans are common among construction and property groups. These will now be recognised at fair value. The terms, conditions and circumstances of the loan will determine the impact of this, but generally complications lie with long-term intra-group loans on which interest is not charged at a market rate. These will require adjustments to reflect the fair value of the loan and can result in different amounts being reported in the debtor and creditor companies.

Fair value also underpins the accounting treatment for investment properties. These will now be measured at fair value at each period end. Of course the implications of FRS102 will not only apply to the construction industry and companies are urged to seek the advice of professionals.