FRC comments on issues arising in relation to accounting for social housing loans

News types: Codes and Standards Announcements

Published: 2 June 2016

Many entities are currently in the process of applying FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland for the first time.  The Financial Reporting Council (FRC) recently became aware that issues of interpretation have arisen in relation to the accounting for loans provided to registered providers of social housing, which could have a significant impact on their financial statements.  Similar loans may exist in other sectors, though they appear most prevalent in the social housing sector.

The issue relates to the classification of loans as ‘basic’ or ‘other’ by registered providers of social housing, which then impacts on whether the loans are measured on a cost or a fair value basis. Paragraph 11.9 of FRS 102 sets out the conditions for a loan to be classified as basic and consequently measured on a cost basis. 

It is common for loan agreements to include a provision setting out amounts to be paid by the borrower to the lender as compensation should the borrower repay the loan early and current market interest rates are lower than the fixed rate specified in the agreement. FRS 102 explicitly states that such provisions do not prevent the loans being classified as basic.

We have been informed that many otherwise straight-forward fixed rate loan agreements, particularly in the social housing sector, include a variant of such a provision. These provisions require the borrower to pay the lender or the lender to pay the borrower, depending on whether current market interest rates are below or above the agreed fixed rate.

FRS 102 does not explicitly address compensation that can be paid to the borrower. We understand there are divergent views, based on differing interpretations of one of the qualifying conditions, over whether such loans can be classified as basic. Those advocating a basic classification have also argued that the resulting measurement of the liability, based on cost, provides more relevant information, by better reflecting the intentions of the contracting parties in entering into the agreement and their expectations of future actions.

The FRC notes that FRS 102 does not explicitly address every transaction, other event or condition that an entity may need to account for, and preparers and auditors will need to apply judgement in the application of FRS 102.  This may lead to diversity in practice in some areas. In some cases the FRC may take action to reduce diversity in the future by making amendments to standards.

In situations where standards do not specifically address the required accounting, different, valid interpretations can, and do, occur. The classification of loans with two‑way compensation clauses appears to be one such case.  The FRC reviews areas where it is aware of significantly conflicting interpretations emerging, and in this case will consider any need to revise the requirements of FRS 102, in due course, and after due process, with a view to clarifying the accounting requirements whilst ensuring that the economic substance of the agreements is reflected.

In relation to this specific issue, the FRC notes that diversity in practice may arise and reminds preparers that FRS 102 (paragraph 8.6) requires disclosure about judgements that have had a significant effect on the amounts recognised in the financial statements. Looking forward, the FRC is starting work on the triennial review of FRS 102, and expects to reconsider the conditions in paragraph 11.9 as part of that process. As well as considering this compensation clause, this will also include consideration of any other issues raised in relation to the application, in practice, of paragraph 11.9. As a result any amendments will reflect wide experience of applying FRS 102. The FRC expects to consult on any proposed amendments early in 2017, which would be effective from 1 January 2019, although early application may be available.