EU Accounting Directive: UK Government’s response

On 29 August 2014, the Department for Business Innovation and Skills (BIS) issued a consultation document on how it intends to implement the new Accounting Directive. In addition, the government also embarked on proposals to make changes to the accounting regime which were in response to issues that had been raised during the Company and Commercial Law Red Tape Challenge process.

In January 2015, BIS issued their response to the implementation of the EU Accounting Directive and confirmed that in total 33 responses had been received and there was broad support for the proposals.

In terms of timing, the Statutory Instrument is expected to come into force early this year. The Financial Reporting Council are expected to release their response to the new financial reporting framework and the impact this will have on accounting standards in March this year (it is expected that the FRSSE will be withdrawn, although nothing to this effect has been formally announced). BIS have stated that companies will be required to apply the new financial reporting framework for financial years commencing on or after 1 January 2016. Earlier adoption of the new framework will be available where so doing will enable a company to access a less burdensome reporting regime.

Impact of the EU Accounting Directive

The impact of the Accounting Directive is wide-reaching and will have an impact on most (if not all) accountancy practices and their clients. The following outlines the intention by BIS:

Changes to the small company qualification criteria

BIS will take advantage of the maximum thresholds that are available to Member States in order to determine the size of small companies. BIS has stated that this will allow 11,000 medium-sized companies to be re-categorised and allow them to take advantage of the small companies’ regime and hence apply less disclosure in their financial statements. BIS has also confirmed that it will also apply mandatory increases in the thresholds for medium-sized and large companies.

As a result, a maximum threshold of £10.2 million in net turnover, a balance sheet total of £5.1m and an average number of employees during the financial year of 50 will apply for a small company. To qualify as a small company, the undertaking must not exceed two out of the three criteria.

Small groups will have a net balance sheet total (see *) of £5.1m and a gross balance sheet total* of £6.1m (reference to ‘net’ means intra-group trading and the effects thereof have been eliminated whereas ‘gross’ means intra-group trading and the effects thereof have not been eliminated). Small groups will have net turnover of £10.2m and gross turnover of £12.2m with an average number of employees of 50. Again, small groups must not exceed two out of the three criteria.

*Where reference to the ‘balance sheet total’ is made, paragraph 3 of Article 11 of the EU Accounting Directive says:

“The balance sheet total referred to in paragraph 1 to 7 of this Article shall consist of the total value of the assets in A to E under ‘Assets’ in the layout set out in Annex III or of the assets in A to E in the layout set out in Annex IV.”

Therefore, balance sheet total is fixed plus current assets (not net assets!)

The micro-entities criteria is:

• Net turnover                  £632,000
• Balance sheet total       £316,000
• Employee average        10

The micro-entity qualification criteria says that undertakings must not exceed two of the above three criteria.

Reduction in disclosure notes

There will be a maximum of 13 mandatory disclosure notes under the new small companies’ regime (where these are appropriate). The directors of a company will still, however, have a duty to ensure that the financial statements give a true and fair view and where the mandatory 13 disclosures notes fail to achieve a true and fair view, additional disclosures must be made to enable them to do so. This is likely to be burdensome for directors of small companies and in reality they will more than likely seek advice from their accountant (or their accountant will advise on which disclosures are necessary to enable a true and fair view to be given). The 13 disclosures are as follows:

1. Accounting policies adopted
2. Fixed assets revaluation table
3. Fair valuation note
4. Financial commitments, guarantees or contingencies not included in the balance sheet
5. The amount of advances and credits granted to members of the administrative managerial and supervisory bodies (along with supporting information)
6. Exceptional items
7. Amounts due or payable after more than five years and entire debts covered by valuable security
8. Average number of employees during the financial year
9. Fixed asset note (in addition to the mandatory revaluation table)
10. Name and registered office of the undertaking drawing up the consolidated financial statements of the smallest body of undertakings of which the undertaking forms part
11. Nature and business purpose of arrangements not included in the balance sheet
12. Nature and effect of post balance sheet events
13. (Limited) related party transactions.

The EU Accounting Directive says that Member States may require mutatis mutandis that small undertakings are to disclose:

• Fixed asset note (in addition to the mandatory revaluation table)
• Name and registered office of the undertaking drawing up the consolidated financial statements of the smallest body of undertakings of which the undertaking forms part
• Nature and business purpose of arrangements not included in the balance sheet
• Nature and effect of post balance sheet events
• (Limited) related party transactions

BIS has decided to require the above optional disclosures as mandatory in the UK on the basis that it does not view them as being overly burdensome and are important for a proper understanding of the company’s accounts.

Abbreviated accounts

The new regime will allow small companies to prepare an abbreviated balance sheet and an abbreviated profit and loss account but only if this has been approved by all of the company’s shareholders. The consultation document included the question:

“Do you agree that small companies should have the choice of preparing an abbreviated balance sheet and profit and loss account if they wish?”

Of the responses, eight agreed, 21 disagreed and three were uncertain. The government said that:

“It is important that shareholders receive appropriate information on the performance of companies in which they invest. Therefore, small companies will only be permitted to prepare abbreviated accounts with the consent of all members of the company.”

BIS has suggested that allowing small companies to prepare an abbreviated balance sheet and abbreviated profit and loss account only if approved by all of the company’s shareholders will strike a balance between enabling simplification and protecting minority shareholder interests.

Flexibility for public companies

BIS intends to allow companies which are in the same group as a public company, but which are not listed companies, to have access to the small or medium-sized companies’ regime.

Flexibility in financial statement layouts

BIS intends to give companies the opportunity to have flexibility in how their profit and loss accounts and balance sheets are prepared. There is a condition, however, where this will be concerned and that is that the information provided in the profit and loss account and balance sheet must be at least equivalent to the information which would otherwise be required by the standard formats.

The idea of allowing companies the flexibility in layouts is to reduce the burden of consolidation for those in a group using IFRSs. This will allow much simpler application of FRS 101 Reduced Disclosure Framework which still requires Companies Act accounts to be prepared and therefore can (at present) cause difficulties when it comes to consolidating the current Companies Act financial statements in with accounts prepared to EU-endorsed IFRS.

Goodwill

There has been some controversy surrounding FRS 102’s treatment of goodwill (and other intangible assets) where management are unable to arrive at a useful economic life. FRS 102 currently says that where management are unable to arrive at a useful economic life, it is written off over a five-year period.

BIS is going to change this lifespan and require that, in exceptional circumstances, where the useful economic life of goodwill cannot be estimated reliably, it is to be written off over no more than 10 years.

Subsidiaries information

Information on subsidiaries which have been included within the consolidated financial statements will only be required as a note to the consolidated financial statements.

Micro-entities directors’ report

Very small companies (micro-entities) which satisfy the criteria as a micro-entity (see above) will not be required to prepare a directors’ report. In their consultation document, the Financial Reporting Council have also proposed further simplifications to the micro-entities regime.

Use of the ‘equity method’ in individual financial statements

Article 9.7 of the Directive allows Member States the option to permit (or require) participating interests to be accounted for using the equity method in an investor’s individual financial statements. For clarity, Article 2(2) says that “participating interest”:

“means rights in the capital of other undertakings, whether or not represented by certificates, which, by creating a durable link with those undertakings, are intended to contribute to the activities of the undertaking which holds those rights. The holding of part of the capital of another undertaking is presumed to constitute a participating interest where it exceeds a percentage threshold fixed by the Member States which is lower than or equal to 20%.”

In addition, the Directive allows Member States to permit (or require) that the proportion of the profit or loss which belongs to the participating interest be recognised in the investor’s profit and loss account only to the extent of the amount corresponding to dividends already received (or the payment of which can be claimed).

Presently, Companies Act 2006 does not allow the investor to use the equity method in their individual accounts (only cost-based and fair value measurements are allowed). BIS intends to allow the use of the equity method in the individual company financial statements.

Other issues

Further issues of relevance to the new regime are as follows:

• The definition of ‘net turnover’ will not be amended to include other sources of income. However, for charities, BIS recognises that often charities receive a significant proportion of their income from sources other than sale of goods and rendering of services and hence they will continue in discussions with the Charity Commissioners concerning this issue.
• The government will not take action to de-couple the link between the small company thresholds for both accounting and audit purposes and they have said that the status-quo will be maintained and permit audit exemption thresholds to rise automatically in line with the increase in the small company accounting thresholds. The government is currently inviting stakeholder views on whether new separate lower thresholds should be introduced for the small companies’ audit exemption and if it is deemed appropriate to introduce different thresholds for small companies’ it will legislate for this change later in 2015.

Category: Accounting and standards