In a previous blog I reported on European Commission proposals to revise the directive that underpins the accounting requirements in UK company law. Our FAQs explain these proposals in more detail.
Since then, both our Financial Reporting Committee and the dedicated working party we’ve formed to consider the various accounting simplification proposals for small and micro entities have been weighing up the likely implications of this draft legislation. A briefing paper for policy makers in Brussels and London that outlines some of those implications has been produced and in this blog I set out its key messages:
The new directive would radically simplify the disclosures small companies are required to make in the ‘full’ accounts they prepare for their members. The simplified small company disclosures are accompanied by a maximum harmonisation provision that may mean EU countries are effectively prohibited for requiring any additional disclosure in their local legislation. The final implications for the UK accounting regime are not yet clear in a number of respects but it may be that many of the disclosures familiar from FRSSE might need to be withdrawn.
ICAEW strongly supports the work of the European Commission to reduce ‘red tape’ and other administrative burdens for companies, particularly small companies, and broadly support the efforts of the Commission to achieve significant simplification of the European level accounting regime. However, our working party strongly opposed maximum harmonisation in this area. Given the potentially far reaching implications of the changes, Member States should have the opportunity to consult on and evaluate the potential implications of the new disclosure regime in the light of local conditions and circumstances. In the UK, an effective regime, proportionate and tailored to the size of company is in place, and anecdotal evidence suggests that for entities using software to prepare accounts the cost of including additional notes derived from the trial balance is minimal. At the same time, it may be that external investors and the many other users of the published financial information of small companies are disadvantaged by the reduction in disclosure.
Public benefit entities
Our briefing urges policy makers to be mindful of the potential implications of the small company proposals for public benefit entities. In the UK, many charities have incorporated as companies and would fall under the provisions of the Directive. The financial reporting of such entities has involved high standards of transparency and accountability under the UK SORP-based regulatory regime, and it would be particularly unwelcome if this were compromised by the new directive.
An earlier, separate legislative process has been looking at providing exemptions for micro companies from the accounting requirements of the directive and a limited set of accounting simplifications for these companies are now due to be adopted shortly into EU law. Micro companies are defined in the approved text as those not exceeding two out of three of:
Total assets €350k
The precise form the new rules will take for UK companies will be decided by the UK government, as the exemption is a Member State option. The stated aim of the exemption is to simplify reporting by micro companies by:
Reducing the categories required to be disclosed on the face of the balance sheet and profit and loss account
Limiting note disclosures to: own shares held, financial commitments and advances to directors
Specifically allowing companies not to recognise prepayments or accruals as long as they do not relate to ‘the cost of raw materials and consumables, value adjustments, staff costs or tax’.
The responses to the recent UK BIS/FRC consultation on simplifying micro-entity accounting has shown that this is a complex issue. The non-recognition of accruals and prepayments is likely to lead to a reduction in the usefulness of micro entity financial statements without any significant reduction in costs. At the same time, the rationale for a reduced regulatory regime for micros has been weakened given the proposed disclosure reductions for all small companies contained in the proposed new directive.
Ultimately it is essential that the UK government first undertakes rigorous enquiry and consultation on the implications of the exemptions before any decision is taken on exercising the Member State option.
Related party disclosures: The current related party disclosure exemption for transactions between wholly-owned subsidiaries would be removed. For entities reporting under UK GAAP the extension in disclosure that this would entail is likely to involve significant cost and effort; indeed for small companies, this is often one of the more complex note disclosures. Whilst we agree that related party disclosures in general provide important useful information to users, the benefits of disclosures relating to wholly-owned subsidiaries are less apparent. Accordingly, we feel that the exemption should be preserved.
Merger accounting: Merger accounting is widely-used when accounting for group reconstructions involving entities under common control (such as subsidiaries), but it would not be permitted under the new directive. This change would increase administrative burdens and we believe that in the UK there is strong support for retention of the current regime.
Reference to ‘profits made’: Article 5.1 (c i) of the proposed directive restates the existing requirement that ‘only profits made at the balance sheet date may be recognised’. This provision appears to us to be superfluous, as transactions recognised in profit or loss are governed by GAAP and consequently are not actually limited in practice by Article 5.1 (c i).
Revaluation reserve: Article 6.2 of the proposed directive imposes restrictions on distributions from the revaluation reserve, but these are inconsistent with the status of the fair value reserve, which is dealt with under the fair value accounting rules. This gives rise to the need for the inclusion of many exceptions in the accounting directive, which adds unnecessary complexity.
Accounts formats: The directive proposes the removal of some of the primary statement formats currently available under the Companies Act. Unfortunately it seems that one of those scheduled for removal is the one currently most popular in the UK. We are strongly opposed to the removal of this format.
Interim management statements: The proposed changes to the transparency directive will abolish the requirement for listed companies to publish interim management statements and/or quarterly reports. We welcome the abolition of this requirement. In the UK, the level of information provided in IMS has been inconsistent and has not led to any significant improvement in the information available to investors.
Have your say…
Discussions are progressing rapidly in Brussels and an initial vote on the proposals is expected in the summer. What do you think? Share your views below or email firstname.lastname@example.org.