July/August 2013

Financial Reporting Update

Insurance accounting - changes for UK GAAP entities

The FRC has issued its proposals for insurance contract accounting for those entities that will apply FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland. Whereas FRS 27 and the ABI SORP apply generally only to insurance companies, draft FRS 103 would apply to all entities, regardless of whether they are an insurer or not.

The Financial Reporting Council (FRC) has issued FRED 49 (Draft FRS 103) Insurance Contracts, which sets out its proposals for insurance contract accounting for those entities that will apply FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland. The new standard would apply to insurance contracts (including reinsurance contracts) that an entity issues and reinsurance contracts that an entity holds. It would also apply to financial instrument contracts with discretionary participation features that an entity issues. Current requirements for insurance accounting in the UK apply generally only to insurance companies but draft FRS 103 would apply to all entities, regardless of whether they are a regulated insurer or not.

The draft standard consolidates the existing texts in FRS 27 Life Assurance and the Association of British Insurers’ Statement of Recommended Practice (ABI SORP) with IFRS 4 Insurance Contracts.  Consequently, it retains many of the current rules thus allowing entities the choice of maintaining their existing insurance accounting policies (subject to some limited exceptions/restrictions) or aligning their accounting policies more closely with the underlying IFRS 4 provisions. The aim of the new standard is to focus on the principles to be applied to insurance contract accounting rather than being overly prescriptive.

The key areas of change for entities are set out in the table below:

Area of change Key change Types of entity affected
Continuation of current accounting policies vs. making improvements Draft FRS 103 largely permits entities to continue with their current accounting policies, although the IFRS 4 options to ‘improve’ accounting policies have been retained. All entities
Definitions FRS 102 introduces the IFRS 4 definition of an insurance contract. For life assurance entities that do not currently apply FRS 26, there will be a change to the accounting for any investment contracts. Entities with investment contracts
Subsidiary exemptions Under FRS 27, 90 per cent subsidiaries have an exemption from making a range of disclosures about liabilities and capital. This exemption is not carried forward into draft FRS 103. Subsidiary entities
Capital disclosures FRS 102 requires entities to disclose information about capital. In a relaxation of the current rules, many of the detailed requirements in FRS 27 are included in draft FRS 103 as guidance only. Life assurance entities
Claims development The requirement for claims development tables has been expanded from the Companies Act requirement to include more years of account. General insurance entities
Equalisation provisions IFRS 4 does not permit the recognition of an equalisation provision. For any entity applying FRS 101 (i.e. full EU-IFRS with reduced disclosure), an amendment to FRS 101 is proposed such that recognition of an equalisation provision is permitted. Schedule 3 of the Regulations*  requires recognition of equalisation provisions. General insurance entities

* SI 2008/410 The Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008

The FRC’s consultation runs until the end of October and a final standard is expected in 2014. These proposals may mean added complexity for some and additional disclosures for many so it is important to start working on conversion now in order that you can understand the options available and the potential impacts.

Some of the practical issues you may need to consider include systems changes/implementation; tax planning; changes for covenants; and any additional training/resource requirements. Further discussion and guidance on these new proposals for insurance contract accounting is available in our Insurance Dispatch publication, which is available to download from our web site. Alternatively, please speak to your usual KPMG contact.



Accounting for UK R&D expenditure credit

A new research and development expenditure credit scheme has been introduced in the UK for larger companies. Under this scheme, depending on  a company’s particular circumstances, the credit may be accounted for within profit before tax rather than as a tax credit.

The UK government has introduced a new research and development expenditure credit (RDEC) scheme that will replace the current R&D tax credit system for larger companies in the UK.

The new RDEC scheme will be available for qualifying expenditure incurred on or after 1 April 2013 and will initially run alongside the existing R&D tax credit system. Until 1 April 2016, UK companies can choose whether to apply the existing scheme or RDEC: RDEC will replace the existing scheme on 1 April 2016. Once a claim is made under the new regime, future claims also have to be on this basis.

The new RDEC scheme was substantively enacted on 2 July 2013. No claims could be made under the new RDEC scheme before the legislation was fully enacted (this occurred when the Finance Act 2013 received Royal assent on 17 July) but claims made for periods ending on or after the date of enactment may include R&D expenditure incurred from 1 April 2013. For full and interim reporting periods ending 30 June 2013, the existing R&D accounting policy should be applied.

One of the government’s aims in changing the current scheme is to encourage more research and development by large companies by making the benefits 'more visible and certain'. The credit is taxable itself and is administered through the tax system, although it is not specifically a tax measure. However, the amount payable can in some circumstances be affected by the tax situation of the company. In our view there is an accounting policy choice to take the credit 'above the line' within profit before tax or as an income tax credit, which is the approach generally adopted under the existing R&D tax credit regime.  In making the appropriate choice it is likely that companies would have regard to their own particular circumstances and the way in which they expect to recover the credit.

Deciding between 'above the line' and tax
For those reporting under EU-IFRSs, some forms of government assistance fall within the scope of IAS 20, the standard dealing with government grants, and others fall within the definition of an ‘income tax’ and are therefore covered by the taxes standard.  We do not believe that the RDEC falls directly within either standard, since it is government assistance delivered through the tax system but which relates to specific expenditure rather than, for example, being a reduction in the tax rate.

In our view it should therefore be accounted for by analogy either as a government grant under IAS 20 ('above the line') or as a tax under IAS 12, whichever best reflects the economic substance of the arrangement.  This should be judged in the light of all relevant facts and circumstances. 

One of the key policy aims of the RDEC is to ensure that companies derive the same benefit irrespective of their corporation tax position and some of the characteristics of the new credit would support 'above the line' accounting in many cases.  However, there are also arguments in support of accounting for the credit as a tax, in the same way as for the existing R&D tax credit.

Practice in this new area may develop over time but at present it is likely to be mixed and it will be difficult to rule out either approach.  As noted above, companies will need to consider the characteristics of the RDEC in the light of their own particular circumstances in determining which of the two treatments best reflects the way in which they will benefit from the new credit.

Treatment as a grant
To the extent that the credit relates to R&D expenditure that has been capitalised, it will either be deducted from the intangible asset’s carrying value or be recognised as deferred income.  If the R&D has been expensed, the credit will be taken to the income statement, either as a reduction in that R&D cost or as income (e.g. other income).  The credit is taxable and that tax will be included as part of the tax charge for the period, with the gross amount shown above the line.

The credit is recognised once there is reasonable assurance that the company will comply with the conditions of the RDEC and that it will be received.  We expect that companies generally will be able to make a reasonable estimate of the amount to be received in respect of the period. 

Treatment as tax
The credit would be presented as a deduction from the current tax expense, to the extent that the company is entitled to claim it for the current reporting period.  Any unused amount would be recognised as a deferred tax asset if it met the general recognition criteria for deferred tax assets.

Broadly speaking, the same analysis as set out above would apply under UK GAAP.


Changes to UK corporation tax rates

The main UK corporation tax rate will reduce from 23 per cent to 21 per cent from 1 April 2014 and to 20 per cent from 1 April 2015. For balance sheet dates before 2 July 2013, deferred tax balances continue to be measured based on a rate of 23 per cent.

As proposed in the UK Budget on 19 March 2013, further reductions in the main UK corporation tax rate were substantively enacted on 2 July 2013. The rate (currently 23 per cent) will reduce to 21 per cent from 1 April 2014 and to 20 per cent from 1 April 2015.

For June 2013 (and December 2012) full and half-year ends, deferred tax balances continue to be measured based on a rate of 23 per cent. Any significant effect on future current tax and on deferred tax balances of the rate reduction should be disclosed.

For balance sheet dates on or after 2 July 2013, deferred tax balances should be remeasured based on a rate of 23, 21 or 20 per cent depending on the expected timing of reversal of the related timing or temporary difference.

The recognition of the effect of the remeasurement will depend on where the original entry to recognise the deferred tax was recorded. For example, the effect of remeasuring the deferred tax liability under IAS 12 in relation to an upwards revaluation of own-use property (above cost) will be recognised in other comprehensive income.


ICAEW guidance on subsidiary audit exemption by parent guarantee

The ICAEW’s recently issued TECH 7/13 provides guidance on the exemption from audit by parent guarantee under the new sections 479A to 479C of the Companies Act 2006.

The Institute of Chartered Accountants in England and Wales (ICAEW) has issued TECH 7/13 Exemption from audit by parent guarantee.


This provides guidance (in Frequently Asked Question format) on the exemption from audit under new sections 479A to 479C of the Companies Act 2006. As set out in the August/September/October 2012 Update, for accounting periods ending on or after 1 October 2012, a company that is itself a subsidiary undertaking can be exempt from audit under sections 479A to 479C if all of its liabilities are guaranteed by the parent, and all of the conditions set out in those sections are met.

Failure to meet all of the required conditions means that there is no audit exemption, even if the guarantee has been given.



News in Brief

Changes to narrative reporting
SI 2013/1970 The Companies Act 2006 (Strategic Report and Directors' Report) Regulations 2013 introduces changes to the Companies Act 2006 requirements for financial years ending on or after 30 September 2013. The principal changes include moving the business review from the directors' report to a new 'Strategic Report' and aligning the new requirements with the September 2012 edition of the UK Corporate Governance Code.


In response to the issue of the new regulations, the FRC has issued its draft Guidance on the Strategic Report for consultation, which is open for comment until 15 November 2013. Once issued, the final Guidance on the Strategic Report will replace the Reporting Statement: Operating and Financial Review (RS 1). It has also prepared a Staff Guidance Note: The Companies Act 2006 (Strategic Report and Directors’ Report) Regulations 2013 – Key Facts, which sets out the key features of the Regulations.


The changes to narrative reporting will be discussed in more depth in the next issue of Update. In the meantime, further guidance is available in KPMG’s Audit Committee Institute's (ACI) publication, New narrative reporting regulations, available from KPMG's ACI web site.

FRS 102 – financial instruments’ exposure draft
The FRC plans to issue supplementary exposure drafts proposing amendments to FRS 102 in relation to hedge accounting and impairment of financial assets when the IASB completes the relevant sections of IFRS 9 Financial Instruments.

Under FRS 102, entities have a choice to apply either Sections 11 and 12 of FRS 102, or the recognition and measurement requirements of IAS 39 Financial Instruments: Recognition and Measurement and/or IFRS 9 along with the disclosure requirements of FRS 102.  Sections 11 and 12 of FRS 102 broadly apply the classification and measurement requirements of IFRS 9 but apply the impairment and hedge accounting requirements of IAS 39 (since the equivalent IFRS 9 requirements are still under development by the IASB).  For entities with financial instruments that are considering their accounting policy choice, the exposure draft on hedge accounting in particular (once issued), is likely to affect this decision.

Continuing hedge accounting after derivative novations
The IASB has published Novation of Derivatives and Continuation of Hedge Accounting (Amendments to IAS 39), providing relief from discontinuing hedge accounting in respect of an existing hedging relationship when a novation that was not contemplated in the original hedging documentation meets specific criteria.

The amendments apply for annual periods beginning on or after 1 January 2014 (subject to EU endorsement) and may be applied early.

Activity report on IFRS enforcement in 2012: areas for improvement
The European Securities and Market Authority (ESMA) has issued its activity report on IFRS enforcement activities in Europe in 2012. 

The report concludes that overall the quality of IFRS financial statements continued to improve but notes that the quality of financial reporting needs to improve for:

  • application of the classification criteria for assets held for sale;
  • determination of the discount rate for the calculation of defined benefit obligations;
  • classification and measurement of financial instruments;
  • assessment of goodwill impairment;
  • distinction between a change in an accounting policy and an accounting estimate; and
  • disclosures about the risks and uncertainties or judgements and estimates used in preparation of IFRS financial statements.


IFRS newsletters and other publications

KPMG IFRG Limited has published the following since the May/June 2013 Update, which are available on its web site at http://www.kpmgifrg.com/:

New on the Horizon: Leases for banks (July 2013)
New on the Horizon: Insurance contracts (July 2013)


KPMG IFRG Limited also publishes In the Headlines, which provide information in relation to new exposure drafts and standards issued by the IASB, as well as any other relevant developments affecting current and future IFRS reporters.

In the Headlines, Issue 12 – Cost accounting for bearer plants
In the Headlines, Issue 13 – Continuing hedge accounting after derivative novations
In the Headlines, Issue 14 – Enhancing the value of auditor reporting



Insurance accounting - changes for UK GAAP entities »

Accounting for UK R&D expenditure credit »

Changes to UK corporation tax rates »

ICAEW guidance on subsidiary audit exemption by parent guarantee »

News in Brief »

IFRS newsletters and other publications »