FRED 54….Leaves Us Waiting For More (Clarity)
On February 13th the FRC published the eagerly anticipated (no, really) FRED 54, containing the proposed amendments to the conditions which must be met in order to account for a debt instrument as “basic”. Basic accounting treatment will allow reporting entities to apply benign amortised cost accounting to their debt instruments, thus avoiding the various unpleasant consequences associated with having to fair value debt in the accounts. Fair value accounting is of particular concern to many of our clients with long dated debt instruments – with fair values which are highly sensitive to market conditions and which often vary dramatically from their historic “cost” book value.
FRED 54 starts off positively enough with… “the draft amendments propose to make the conditions that basic debt instruments have to meet less restrictive and aim to achieve the following:
(a) to allow a wider range of debt instruments to be measured at amortised cost where this is a relevant measurement basis;
(b) to align the measurement requirements for ﬁnancial instruments more closely with those of IFRS 9 Financial Instruments issued by the IASB; and
(c) to reduce the cost of compliance with FRS 102”
Notwithstanding these laudable intentions, the all-important paragraph 11.9 which lists out the basic conditions has been expanded from four to six “conditions”. In our view, these are arguably no more clear in certain areas and still leave a number of unanswered questions. Furthermore, it does not seem that some of the new conditions are even conditions. Paragraphs 11.9(b) and 11.9(c) for example appear to be an extension of 11.9(a), rather than conditions to be met in their own right. Paragraph 11.9(c) is particularly confusing – it does not seem at all clear to us which types of debt instrument that “provide for a variation of the return to the holder” the FRC is intending to be treated as basic.
While there are clearly positive points to note – helpfully, both (i) debt where the interest rate can vary over time, and (ii) inflation linked debt, each get an explicit mention – we still find ourselves going slightly goggle eyed when trying to work out whether some common and essentially benign “non-vanilla” borrowing arrangements could be made to fit with the new paragraph 11.9 criteria. The examples in the Appendix of FRED 54 are also rather arcane and do not really provide us with any useful guidance.
So where does FRED 54 leave us? Firstly, we don’t think this is the final word for basic financial instruments, and we are not the only ones. While FRED 51 on hedge accounting seemed to hang together quite well and therefore seems to us quite likely to find its way into the final FRS102 standard largely unaltered, FRED 54 unfortunately seems like a rather poorly drafted effort which ultimately fails to provide clarity in key areas.
Secondly, in terms of timescales, the end of the FRED 54 consultation period is 30th April 2014. This is obviously rather frustrating and unhelpful for those entities with 31st March 2014 year ends and seems to confirm that many reporting entities will now face transitioning into FRS102 without clarity on the new accounting treatment for their debt.
However, taking a glass half full approach, we welcome the fact that the FRC has clearly stated its objective to allow a wider range of debt instruments to be treated as basic, so we can all take comfort from their apparent intention, even if they are still struggling to set out the detail clearly and logically after two attempts. We can only hope that it is a case of third time lucky… In addition, where there are areas of uncertainty requiring interpretation, auditors may feel more comfortable to base their interpretations on more accommodative (in some areas) IFRS 9 rules, given the FRC’s stated intention to align FRS102 chapter 11 more closely with international standards.
Finally, while this is not the perfectly clear set of rules that we might have hoped for, we can still see completely reasonable arguments in favour of treating the vast majority of our client’s debt instruments as basic, subject to ironing out some minor points of interpretation.
Centrus intends to respond to the FRED 54 consultation on behalf of its clients and would welcome any feedback on the amendments proposed by FRED 54.