The Financial Reporting Council have replaced the current UK GAAP with FRS 102 which is based on the International Reporting Standards for small and medium size entities. FRS 102 will replace all existing UK standards for all medium and large companies. Adoption will be mandatory for all financial years beginning on or after 1 January 2015. FRS 102 may be adopted by small companies.

The full range of accounting changes are outside the scope of this article which briefly summarises some of the effects that the changes might have on the financial covenants sometimes contained in loan agreements.

The financial covenant package basically requires a number of ratios to be met – earnings/profit to debt, earnings/profit to finance costs and asset value to loan value – during the life of the loan. If these are not met then an event of default has occurred which subject to any cure provisions entitles the lender to seek immediate repayment of the loan. So, the impact of the changes introduced by FRS 102 need to be analysed in that context. For example, there may need to be a discussion between borrower and lender to amend the financial covenant package and reset the ratios if the changes in accounting treatment produces results which neither party envisaged at the time the covenants were originally negotiated.

The main areas where financial covenants could be impacted are:

Investment properties

Prior to the new FRS 102 changes to the value of an investment property were taken through a revaluation reserve. Under the new FRS 102 changes in the fair value of an investment property as at the balance sheet date will be recognised through the profit and loss account. So, unrealised increases or reductions in value have the potential to affect the figure for profit unless the definitions in the financial covenant package allow such fluctuations to be ignored.

Financial instruments

Going forward under FRS 102 it will be possible for changes in the value of swaps and other financial instruments to have an impact both on the balance sheet and the profit and loss account. The fair value of such contracts will have to be recognised on the balance sheet and any movements in the value for a year recognised through the profit and loss account. So, some borrowers will find that the value of these financial instruments may affect covenants related to asset or net asset value. In addition fluctuations in the value could impact the profits for any year and thus affect earnings related financial covenants. Again, the trick will be to ensure that the financial covenants are so constructed as to exclude the undesirable impacts of the change in accounting practice.

Intangible assets and goodwill

Under FRS 102 goodwill has to be written off over a potentially shorter period than before. The period may be as short as 5 years. That will increase the level of charge each year and potentially reduce the net asset figure. Other intangibles will have to be treated in a similar fashion and FRS 102 brings within scope more types of intangible asset than were caught under the previous accounting regime. If assets or net assets forms a component of the financial covenant package these changes could have an impact.


The changes brought about by FRS102 will almost certainly impact the calculation of the figures used in financial covenants in loan agreements. Borrowers should understand the impact of the changes on these covenants and if necessary discuss with their lenders what (if any) changes need to be made to the covenant package to avoid undesirable consequences.