FRS 102 vs FRS 105 for UK startups: Which standard for statutory accounts?

FRS 102 vs FRS 105: Which UK Financial Reporting Standard Is Right for Your Startup?

For UK startup founders, navigating the requirements for statutory accounts preparation can feel like a distraction from the real work of building a business. Yet, the choice between financial reporting standards is more than a compliance task; it is a strategic decision that impacts fundraising, public perception, and operational scalability. The two primary options for early-stage companies, FRS 105 for micro-entities and FRS 102 Section 1A for small companies, offer different paths with distinct advantages and limitations.

Choosing the right one from the start is crucial for financial compliance for early-stage companies. Getting it wrong can lead to rejections from Companies House, create avoidable friction with potential investors, and require costly restatements of your accounts down the line. This guide provides a clear framework for making the correct, strategic choice on which financial reporting standard for a small business in the UK is best for your specific circumstances.

Foundational Understanding: The Starting Point is Your Company Size

Before you can decide which financial reporting standard to use, you must first determine your company's official size according to UK regulations. This is not a subjective measure; it is defined by specific thresholds set by Companies House. The rule is that a company qualifies for a certain size category if it meets at least two of the three criteria for a financial year. Understanding where your startup fits is the essential first step in this decision-making process.

First, a micro-entity must meet at least two of the following conditions:

• Turnover: Not more than £632,000
• Balance sheet total: Not more than £316,000
• Average employees: Not more than 10

Next, a small company must meet at least two of these higher thresholds:

• Turnover: Not more than £10.2 million
• Balance sheet total: Not more than £5.1 million
• Average employees: Not more than 50

These thresholds are applicable for financial years beginning on or after 1 January 2016. The critical distinction is that if your business qualifies as a micro-entity, it automatically qualifies as a small company, giving you a choice between FRS 105 and FRS 102 Section 1A. If you exceed the micro-entity limits but still fall within the small company thresholds, your only option is FRS 102. Misclassifying your company size is a common pitfall that risks filing rejections and can signal a lack of financial control to investors.

Option 1: FRS 105 — The "Simple Start" for Micro-Entities

For businesses that qualify as micro-entities, FRS 105 presents the path of least resistance. It is the simplest form of UK GAAP for startups and is available only to the smallest of businesses. Its main appeal lies in its significantly reduced disclosure requirements, which translates to lower accountancy fees and a faster, more straightforward preparation process for micro-entity accounts in the UK.

Under FRS 105, a company is only required to file an abridged balance sheet with minimal notes to the accounts. Crucially, no profit and loss account or director's report is publicly filed with Companies House. This offers a degree of financial privacy that can be attractive to bootstrapped founders or those in the very early stages who prefer not to disclose revenue and profitability figures to competitors.

While tempting, this simplicity comes with trade-offs. FRS 105 prohibits the use of certain accounting treatments that are vital for growing tech companies. For example, complex concepts like deferred tax, which can be important for R&D-heavy biotech or deeptech firms claiming tax credits, cannot be recognised. Similarly, share-based payments, which are fundamental to employee compensation in many SaaS startups, are not accounted for, meaning the accounts do not reflect their true economic cost. This simplified financial reporting can be a perfect fit for a small e-commerce store or a professional services business with no immediate plans for equity funding, but it can quickly become a limitation for ambitious, high-growth startups.

Option 2: FRS 102 Section 1A — The "Scalable Standard" for Small Companies

FRS 102 is the principal UK Financial Reporting Standard. For small companies, a specific subsection, FRS 102 Section 1A, provides a simplified version of the full standard while still offering a robust and scalable framework. This makes it far better suited for companies on a venture-backed growth trajectory and is a common choice when considering which financial reporting standard for a small business in the UK is best for long-term growth.

The key difference in small company reporting requirements under FRS 102 Section 1A is transparency. A company filing under this standard must submit both a balance sheet and a profit and loss account to Companies House, along with more detailed notes. While this discloses more information publicly, this level of transparency is the standard expectation from professional investors, lenders, and grant-making bodies. It provides a credible, comprehensive view of a company’s financial performance and position.

More importantly, FRS 102 allows for the sophisticated accounting treatments necessary for scaling startups. For instance, share-based payments can be properly valued and expensed, reflecting the true cost of employee stock option plans. This is essential information for investors evaluating dilution and team incentives. Similarly, deferred tax assets, often arising from initial operating losses or R&D tax credits, can be recognised on the balance sheet. This presents a more accurate and often stronger picture of the company's financial health. Opting for FRS 102 Section 1A from the beginning, even if you qualify as a micro-entity, signals financial maturity and readiness for due diligence.

Making the Right Call: A Decision Framework for Founders

Choosing your UK accounting standard is a strategic choice, not just an eligibility test. While your startup might qualify for the simplicity of FRS 105, it may not be the wise long-term decision. The right call depends entirely on your business model, growth ambitions, and funding strategy. This framework can help guide your decision.

Funding Stage and Investor Type

If you are bootstrapped, self-funded, or only using capital from friends and family, FRS 105 is often sufficient. These stakeholders typically do not require detailed financial reporting. However, if you plan to seek angel investment, venture capital, or significant government grant funding within the next 18 months, you should choose FRS 102 Section 1A. Professional investors expect full financial transparency, including a profit and loss account, and will almost always require FRS 102-compliant accounts for their due diligence.

Growth Plans and Scalability

If you expect stable, predictable growth and anticipate remaining a micro-entity for the foreseeable future, FRS 105 is a cost-effective choice. Conversely, if you are planning for rapid scaling and will likely breach the micro-entity thresholds soon, adopting FRS 102 Section 1A proactively is the smarter move. This avoids the disruptive and costly process of transitioning standards during a period of intense operational growth.

Industry Needs and Business Model

Your business model is a critical factor. If your operations are simple, such as in professional services or small-scale e-commerce, and you do not use equity schemes to compensate employees, FRS 105 will likely meet your needs. But if you operate in R&D-heavy sectors like Biotech and Deeptech, or you are a SaaS company issuing share options, FRS 102 Section 1A is practically a necessity. It is the only way to properly account for key assets like deferred tax and major expenses like share-based payments.

A scenario we repeatedly see is a promising SaaS startup that correctly filed under FRS 105 for its first two years to save on costs. When they approached VCs for a seed round, the due diligence team immediately requested financial statements prepared under FRS 102. The FRS 105 accounts were insufficient as they did not show the profit and loss trajectory or properly account for the employee share option scheme. The fundraise was paused for over a month while the founders hired a new accounting firm to restate two years of accounts, a costly and stressful distraction that shook investor confidence. The lesson is that aligning your financial reporting with your funding ambitions from day one is critical.

The Inevitable Upgrade: Planning the FRS 105 to FRS 102 Transition

For a growing startup, outgrowing FRS 105 is a sign of success. However, the transition to FRS 102 is more complex than simply adopting a new standard for the current year. Underestimating the work involved is a common mistake that can derail filing deadlines and budgets. The core of the process involves a look-back exercise to ensure comparability between reporting periods.

The transition legally requires the restatement of the prior year's financial statements as if FRS 102 had always been used. This is a technical task that is beyond the capabilities of most in-house bookkeepers and requires an accountant with specific UK GAAP experience. The process typically involves:

1. Restating the Opening Balance Sheet: Your balance sheet at the start of the comparative period (the beginning of the previous financial year) must be recalculated to reflect FRS 102's accounting policies.
2. Recognising Previously Ignored Items: You must now account for items not permitted under FRS 105. This means calculating values for deferred tax assets, share-based payments, and potentially other financial instruments, and reflecting them in both the current and prior year's statements.
3. Adjusting Your Systems and Disclosures: While your core data in a tool like Xero remains the same, the way it is interpreted and adjusted for statutory accounts changes. The transition is not a Xero task; it is a technical accounting exercise that uses Xero data as a starting point to produce a much more detailed set of accounts and notes.

The practical consequence tends to be a significant, one-off accounting project that costs time and money. Proactive founders plan for this transition well before it becomes a legal requirement, especially if a fundraising round is on the horizon. The best practice is to switch to FRS 102 Section 1A the year before you expect to breach the micro-entity thresholds, ensuring a smooth and predictable changeover.

Practical Takeaways for Founders

Deciding between FRS 105 and FRS 102 Section 1A boils down to a trade-off between short-term simplicity and long-term scalability. While your reports in Xero or other accounting software give you excellent day-to-day management information, your statutory accounts speak to external stakeholders like investors and Companies House. Making the right choice ensures that message is clear and credible.

Here are two guiding principles to simplify your decision:

• If you plan to seek venture capital or significant grant funding, start with FRS 102 Section 1A. Even if you qualify as a micro-entity, adopting this standard from the outset demonstrates financial maturity and ensures you are ready for due diligence without any delays. The extra cost is an investment in your future growth.
• If you are bootstrapped with a simple business model and have no immediate plans for external equity funding, FRS 105 is a perfectly viable and cost-effective option. It minimises your compliance burden while your focus is on achieving product-market fit.

The choice is not just about compliance today, but about positioning your company for its goals tomorrow. Your statutory accounts matter to investors, lenders, and regulators. Discuss these options with your accountant early. Foresight now prevents costly delays and distractions later, allowing you to focus on what matters most: building a successful company.

Frequently Asked Questions

Q: Can a company switch back from FRS 102 to FRS 105?
A: Yes, if a company previously adopted FRS 102 but later meets the micro-entity criteria again, it can transition back to FRS 105. However, this also requires a restatement of prior-year figures and is generally uncommon for startups on a growth trajectory. It's best to discuss the implications with an accountant.

Q: What are the main visible differences in accounts filed at Companies House?
A: The biggest difference is that FRS 105 accounts filed publicly only show an abridged balance sheet with very limited notes. In contrast, FRS 102 Section 1A accounts must include both a balance sheet and a profit and loss account, providing a much fuller picture of the company's financial performance.

Q: Does choosing FRS 102 Section 1A mean my company will be audited?
A: Not necessarily. The requirement for an audit is determined by separate size thresholds. A company generally needs an audit if it meets at least two of the following for the year: turnover over £10.2 million, assets over £5.1 million, or more than 50 employees. Most small companies using FRS 102 Section 1A are exempt from audit.

Q: How much more does it cost to prepare FRS 102 accounts compared to FRS 105?
A: The cost for FRS 102 Section 1A accounts is generally higher due to the increased complexity and disclosure requirements, including valuing share-based payments and calculating deferred tax. The exact difference depends on the complexity of your business, but the investment often pays for itself by making the company "due diligence ready" for investors.