You will be aware of the debate in the sector over the last month or so relating to the accounting treatment for the early repayment of fixed rate debt with two-way break clauses.
The Housing SORP-making Body (SMB) has been in discussions with the Financial Reporting Council (FRC) and the situation has now been clarified, at least temporarily.
Financial Reporting Standard 102 (FRS 102) is silent on how these loans should be classified and, consequently, it has been left to housing association finance directors to interpret whether the loans should be classified as ’basic’ or ‘other’ and to discuss this interpretation with their auditors. Classification is important as it impacts on whether the loans are measured on an amortised cost (for basic) or a fair value (for other) basis, which in turn, impacts on gearing, reserves and, potentially, loan covenant compliance. The value of fixed rate loans affected across the UK is of the order £50bn and the accounting adjustment required could be as much as £5bn.
Audit firms have mixed views on the appropriate classification of these loans. A number of those that believe 'other' is the most appropriate classification confirm that they would be unwilling to provide a clean audit report for those housing associations choosing to account for these loans as 'basic'. This led to an impasse, and because of the magnitude of this issue, many housing associations delayed finalising their accounts until the issue was resolved. This became particular pressing for those housing associations with a 31 December 2015 year end, as they needed to file audited accounts with the housing regulator by 30 June 2016.
Outcome of our discussions
The SMB, which represents the national housing federations in England, Northern Ireland, Scotland and Wales, alerted the FRC to the issue and the impact it is having on members’ financial statements.
We are grateful to the FRC for, after considering a variety of perspectives, responding so quickly by issuing a statement on its website confirming that FRS 102 is not explicit on this issue. So effectively, in the absence of further clarification, housing associations have an accounting choice.
We have since discussed the matter with the main audit firms to the sector in the 'other' camp, and they have confirmed that, in light of the FRC’s statement, they would now be able to provide a clean audit opinion on this issue for housing associations choosing to account for these loans as 'basic', provided housing associations include disclosure about the judgements on the classification of loans that have had a significant effect on the amounts recognised in the financial statements in accordance with FRS 102 (paragraph 8.6). It will be for each association to provide commentary that satisfactorily demonstrates why classification as 'basic' is most appropriate in each circumstance.
In the FRC’s statement, it confirms that this matter will be considered in its first triennial review of FRS 102 during 2017, but any final decision would only be effective from 1 January 2019.
We have impressed upon the FRC that our preferred option is for the FRC to permit the SMB to issue additional guidance, over and above that in FRS 102, recommending how fixed rate debt with two-way early redemption indemnity clauses should be accounted for by housing associations. In the letter sent to the FRC last week, the SMB described particular circumstances relevant to public benefit entities that would suggest classification as basic was most appropriate for housing associations. The Housing SORP Working Party (SWP) will be discussing the matter with the FRC in the coming months. The issue of any additional guidance in the Housing SORP will need to meet requirements of both preparers and users of accounts, and so this would require a consultation process, which would take time to develop and finalise. We will keep you updated you on any developments.
The SMB wishes to express its gratitude to Rob Griffiths, Deputy Chief Executive & Chief Financial Officer, Longhurst Group and Chair, SWP; Sarah Smith, Executive Director Finance & Resources, AmicusHorizon and Vice Chair, SWP; Jonathan Pryor, Smith & Williamson and Technical Advisor, SMB and Guy Flynn, PwC and Technical Advisor, SWP, for their tireless assistance and expertise in resolving this matter with the FRC. The SMB also wishes to thank those members, individual lenders and the Council of Mortgage Lenders who provided independent evidence to the FRC, describing the nature of these financial instruments and how they are used in the sector.
If you wish to discuss this further, please contact your auditor in the first instance, but if you wish to discuss it with the Federation, then I am the contact for this issue.