Small companies regime set for changes

On 29 August 2014, the Department for Business Innovation and Skills (BIS) has announced details of proposals concerning how it intends to transpose the new EU Accounting Directive in the UK and is seeking views on the UK’s proposed implementation of the new directive. The UK has until 20 July 2015 in which to transpose the Accounting Directive into legislation, although adoption of the proposals is planned to take effect for financial years beginning on or after 1 January 2016. The consultation period is open until Friday 24 October 2014.

Summary of the proposals

The Directive is going to replace the 4^th and 7^th Accounting Directive and it establishes minimum legal requirements for financial statements in the EU as well as providing 100 Member State options.  These options will allow approximately 11,000 additional companies to access the ‘lighter-touch’ financial reporting framework which is available under the small company accounting regime.

The main objectives of the new Accounting Directive are to:

• Simplify accounting requirements so as to reduce the administrative burden on companies with particular emphasis focused on smaller companies.
• Increase the clarity and comparability of financial statements of companies. The idea with this is to reduce the cost of capital and increase the level of cross-border trade and merger and acquisition activity.
• Protect essential user needs by retaining necessary accounting information for users.

In order to achieve the above objectives, the Directive:

• Introduces a ‘building block’ approach to the statutory accounts whereby disclosure levels are increased depending on the size of the undertaking.
• Reduces the number of options available to the preparers in respect of recognition, measurement and presentation.
• Creates a largely harmonised small company regime and, for the first time, limits the amount of information which Member States are permitted to require small undertakings to place in their annual financial statements.

Perhaps the most notable of changes relates to the size criteria of companies. The proposals only increase the size criteria for accounting purposes – they are not increased for audit exemption as BIS will consider audit exemption proposals separately at a later date.

The Directive sets out mandatory thresholds for micro, small, medium and large companies which are all relative to:

• The average number of employees;
• Balance sheet total (fixed + current assets); and
• Net turnover at the balance sheet date.

A micro or medium company comes under the relevant size if it does not exceed the limits of at least two of the three criteria. Large undertakings (or groups) are those which on their balance sheet date exceed at least two of the three criteria for medium-sized undertakings (or groups).

The proposals contain a table of the revised proposals as follows:

The Directive also sets out a mandatory minimum threshold for small companies and a company will qualify as small if it does not exceed the limits of at least two of the three criteria. There is an added concession for small companies only in the Directive which allows Member States to increase the balance sheet total and net turnover values by up to 50% so as to allow more companies to access the less burdensome small companies regime if they so wish.

The table below outlines the minimum and maximum thresholds permitted under the proposed small companies’ regime.

The proposals acknowledge that if BIS were to adopt the minimum thresholds which define a small company, this would only offer a small increase of around 7% over the current thresholds and hence just 1,000 medium-sized companies would then fall into the small companies regime. BIS therefore proposes to adopt the maximum small company thresholds so as to allow an additional 11,000 companies access to the small companies regime.

Disclosures

The Directive adopt a ‘think small first’ approach and it has created a small companies’ regime which allows qualifying companies to prepare profit and loss accounts, balance sheets and notes to the accounts which are proportionate to their size and to achieve the information needs of users whilst at the same time imposing a largely harmonised small company regime.

In light of the ‘think small first’ approach, the Directive restricts Member States’ ability to require statutory disclosures from small companies within national reporting regimes and so in the UK this restriction extends to the accounting standards which are published by the Financial Reporting Council as, taken alongside the provisions of Companies Act 2006 and Regulations. Notwithstanding these restrictions, the company would still be under a duty to consider if the financial statements give a true and fair view and therefore may need to provide additional notes in order to achieve a true and fair view where the mandatory notes are considered insufficient for this purpose.

The Directive permits that Member States may only require small companies to provide the following 13 disclosure notes:

Accounting policies adopted

• Fixed assets revaluation table
• Fair valuation note
• Financial commitments, guarantees or contingencies not included in the balance sheet
• The amount of advances and credits granted to members of the administrative managerial and supervisory bodies (with supporting information)
• Exceptional items
• Amounts due or payable after more than five years and entire debts covered by valuable security
• Average number of employees during the financial year
• 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

In relation to the above, Member States need not include five of the above notes as mandatory disclosures which are the:

• 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 considers that provision of all 13 notes to be important for a proper understanding of the company’s accounts and are not viewed by BIS as being overly burdensome for companies and hence it is proposed that all 13 notes should continue to be disclosed in the notes by small companies. As mentioned above, a company would still be required to provide additional notes should it be necessary for the financial statements to give a true and fair view.

In respect of abbreviated financial statements, BIS proposes to take up the option and allow eligible small companies to prepare and publish abbreviated accounts if they wish. The Directive provides an option for small companies to prepare both an abbreviated balance sheet and an abbreviated profit and loss account and this option has previously not been taken up in the UK (small companies generally only publish an abbreviated balance sheet if they so wish) and so BIS is seeking views on whether small companies should have the choice of preparing an abbreviated balance sheet and profit and loss account if they wish.

Other notable proposals

The consultation paper outlines many more changes and proposals for the small companies regime, including:

• Reducing the number of Formats for the profit and loss account from four to two.
• A potential for greater flexibility within layouts of profit and loss accounts and balance sheets.
• Accounting for participating interests using the equity method (rather than cost-based and fair value methods).
• Changes to the maximum period over which goodwill and development costs can be written off. The proposals require that the period must not be shorter than five years and must not exceed ten years. This will only apply where the useful life cannot be reliably estimated
• Information on subsidiaries included within consolidated accounts. The UK currently permits companies to provide this information when submitting the Annual Return to Companies House and this option is proposed to be withdrawn hence the consolidated accounts would provide information relating to subsidiaries and BIS considers the Annual Return option as diluting the meaningfulness of the consolidated accounts.
• Removing the requirement for micro-entities to prepare a directors’ report. Although the proposals do include a requirement that the note on any acquisition of a micro-entity’s own shares appears as a footnote to the abbreviated balance sheet.

The above list is not exhaustive and readers are encouraged to view the published proposals in their entirety.

Conclusion

The consultation is open until 24 October and the BIS is encouraging comments from the business community. Audit exemption limits will remain unchanged for the time being and the BIS will undertake a separate consultation on this matter in due course.

Category: Accounting and standards, Audit