FRS102, the new UK GAAP standard, applicable mostly to non-listed entities since 1 January 2015, makes a number of major changes to the rules of accounting for derivatives.
As a general principle, Sections 11 and 12 require derivatives to be recognised and measured at their fair value on the balance sheet and changes recorded in the income statement (P&L).
This new accounting regime can create significant P&L volatility, impacting reported EBITDA, and distributable reserves which can potentially affect dividend policies. It can also affect the interpretation and reporting of financial covenants, as well as tax. In order to mitigate that P&L volatility, hedge accounting can be applied in some circumstances if entities meet certain requirements.
The new rules present significant concerns for CFOs, Treasurers and Financial Directors who, under the old UK GAAP, did not have to place the same emphasis on the accounting implications of derivatives. As these were typically entered into to hedge against market risks, only the cash flows arising from the derivatives were accounted for and not their fair value (in effect derivatives were off balance sheet items).
This whitepaper will identify the key issues and impacts that may arise from the application of the new accounting rules to derivatives. Both the requirement to implement FRS102 and the use of hedge accounting for derivatives have been well documented elsewhere; instead this paper will address the common challenges and pitfalls associated with FRS102 and how these can be overcome with the right approach.