In theory, the idea of recording assets in financial statements seems fairly straightforward. In practice, there are a number of issues to take into consideration. These issues may restrict the amount of information you are required to release into the public domain. There can also be significant cost factors to take into consideration. So, we will now take a look at how to record assets in financial statements.
Different types of assets
Before we look in depth at how to record assets in financial statements, it is important to recognise the two main classes of asset which are:-
These are generally defined as long-term assets such as land, machinery, vehicles and business premises.
This type of asset will have a much shorter lifespan and include stock, cash in the bank, prepaid liabilities and other liquid assets.
Accounts and tax returns
lt is vital to recognise that there is a material difference between the accounts that you file at Companies House and your tax return to HMRC. While these returns are both based upon the performance and assets of your business, your tax return to HMRC is set in stone. The information which you provide to Companies House, via your company accounts, will vary depending upon:-
- The size of your business
- FRS 102 and FRS 105 reporting standards
We will now take a look at each of these issues in more detail and the impact they have when recording assets in your financial statements.
The size of your business
You will probably have come across the term micro-entity which is used to describe a small company. As part of the Companies Act 2006, qualifying small companies only need to submit a simplified form of their accounts. This is known as a micro-entity account and is covered by FRS 105 Financial Reporting Standard (covered in detail in the next section).
In order to qualify, a company must meet at least two of the following three conditions:-
- Annual turnover of no more than £632,000
- A balance sheet total of no more than £316,000
- An average of no more than 10 employees throughout the year
The idea behind micro-entity account reporting is simple, smaller companies should not be exposed to the same "time-consuming requirements" as large companies. You would still provide the same information to your accountant as any other company, but the accounts would be based on a different format. There are some types of business which will not qualify for the exemption even if they meet the criteria:-
- Not for profit companies
- Public limited companies
- Limited liability partnerships
- Investment undertakings managing a collective pool of investor assets
- Financial institutions
- Subsidiaries of larger companies
As a consequence, using micro-entity accounts you would find it difficult to attract outside investment or secure a loan without giving further information. The additional information required may incur additional fees which should be taken into account.
FRS 102 and FRS 105 reporting
Companies which qualify for micro-entity accounts will submit summary accounts under the FRS 105 Financial Reporting Standard. All companies have the option to submit their accounts under the FRS 102 Financial Reporting Standard which treats assets in a different manner. lt is important to take advice from your accountant whether you should adopt FRS 102 or FRS 105.
Recording assets under FRS 102
Financial Reporting Standard FRS 102, unlike FRS 105, accommodates the revaluation of assets to reflect their fair/current value. IFRS suggests that revaluing assets once every 3 to 5 years is generally acceptable, although volatile assets may need to be revalued on an annual basis. The appreciation/depreciation in the value of the assets would be reflected in a revaluation reserve and make up part of the company's balance sheet.
This would show the net position when taking into account the revaluation reserve. However, the tax liability on the appreciation/depreciation is deferred until disposal of the asset. This is when a chargeable event will occur and any tax liability is crystallised.
While there are obvious costs associated with revaluing assets on a regular basis, especially for larger companies, they can be pivotal in a company's long-term growth. Regular revaluing of assets ensures that a company's accounts are up-to-date and fully reflect the strength/weakness of the business. If the directors believed there was no material change in the value of company assets on an annual basis, they would not be obliged to undertake revaluations for the sake of it.
Small entities can apply to omit profit and loss accounts, directors' reports and various disclosure notes under FRS 102 Section 1A. To qualify they must not exceed at least two of the following three thresholds in the current financial year or the previous financial year (if newly incorporated):-
- Annual turnover £10.2 million
- Gross assets £5.1million
- Average number of employees 50 or less
Even though revaluation reserves will be used when calculating the fair value of assets, these will not be published separately with FRS 102 Section 1A accounts. This figure would be part of a general summary and therefore not specifically identifiable.
Recording assets under FRS 105
The situation when recording assets under FRS 105 is very different to that when reporting assets under FRS 102 (Section 1A or otherwise). A degree of depreciation will be calculated on an annual basis with the carrying cost of individual assets adjusted. Where for example a company owned a building, this would be split into different sections. These different sections might include the heating system, roof, etc which would all be subject to a varying degree of depreciation over time. Consequently, the value of this type of fixed asset would continually depreciate on the balance sheet.
As FRS 105 does not accommodate the revaluation/fair value of assets on the balance sheet, the net asset value can be misleading. The only way to update the net asset value would be to switch to FRS 102 (likely Section 1A) and revalue the assets. This would create a revaluation adjustment and consequently a deferred tax charge. Depending upon the situation, you may need to restate some of the more recent accounts to reflect the switch in financial reporting standard.
Why would a company choose FRS 105?
This prompts the question,why would small companies use FRS 105 when this may undervalue their net asset value. The answer is simple, as these are relatively small companies it is unlikely there would be significant changes in the value of the fixed assets.
When it comes to investment property, while the value of the property would be depreciated under FRS 105, the rental income would be part of the profit and loss account. This would not avoid a potentially large capital gain on the property in the future but would ensure that rental income is taxed each year.
Many people will look at the differences between FRS 102 and FRS 105 and wonder why some companies are keen to avoid full disclosure. In business, it does not make sense to disclose more information to the public than you need to under statutory regulations (as well as keeping costs under control). This ensures that your competitors are not able to benefit from such information but this does not stop you from privately disclosing additional information to trusted parties.
When discussing expansion plans, refinancing, new investment or a takeover, you can provide as much information as required in privacy. As we touched on above, it is also important to note that while information disclosed in your company accounts filing will differ in different circumstances, your HMRC tax filing is standard. Your tax return is also private and not made available to the public.
Therefore, after taking into account the various options, reasons for and against, it is important to take professional financial advice at the earliest opportunity. Your accounting strategy should be assessed on an ongoing basis and adjustments made as and when your situation changes.