To mark this momentous year for UK GAAP, I'm embarking on a mission to work my way through FRS 102, reading a portion on each working day of 2015 and writing a short blog entry on my thoughts and musings (be they few or many).
DAY 68 (23 Jun)
I left yesterday's post on a bit of a cliffhanger (though exactly how many of you read that line and heard 'Dummm Dummm DUUMMMMM!' in your head is a moot point). We haven't quite finished with investment properties, because one of the (potentially) most important changes for such properties is not included in section 16 but instead in section 29. It's the introduction of deferred tax on property gains.
The principle in FRS 19 is that we charge deferred tax on timing differences that arise between accounting and tax treatment of items in the accounts. However this older standard explicitly prohibits recognising a charge and associated liability on the revaluation of fixed assets (unless there is a binding commitment to sell the asset at the balance sheet date).
This prohibition has not carried through to FRS 102 s29. Instead, the new model is 'timing differences plus' - a key 'plus' being the timing differences on fixed asset revaluation. Para 29.16 states that deferred tax on fair-valued investment property is measured using the tax rates and allowances that apply to the sale of the asset, with an exception for certain short-life properties.
So on transition to FRS 102, a property company which has held its portfolio at open market (now 'fair') value will recognise an opening adjustment for the deferred tax on the opening timing difference - the tax that would arise on the capital gain (after deducting indexed cost) were the property to be sold at that value. This will reduce opening net assets and could, in certain cases, jeopardise borrowing covenants if the entity's balance sheet ratios are materially affected. (Note however that the debit to opening reserves should be considered an unrealised loss (since it follows an unrealised gain) and may be posted to the same reserve which records the investment gains on the property - so distributable profits are unaffected). Of course, future gains will attract further deferred tax charges.
Now all this can seem like bad news (that's because it largely is). If there is one silver lining to this gloomy rain cloud, it's that property companies' accounts will more accurately reflect their underlying worth. There have been cases in which listed property companies' market capitalisation has been lower than their reported net assets, simply due to the future tax effects of property sales which have until now been ignored by UK GAAP. But I'll admit it's a pretty slender lining...