Size May Matter: A Summary Of The Government White Paper’s Proposals On Company Reporting, Accounting And Auditing

by Adam Pierson

In 1998 Margaret Beckett, the then Secretary of State for Trade and Industry, launched a company law review ("the Review") resulting in the production of its Final Report in July 2001 ("the Final Report"). In response to the Final Report the Government’s White Paper entitled ‘Modernising Company Law’ ("the White Paper") was published on 17 July this year.

The stated aim of the Government’s new Companies Bill is to: ‘drive enterprise and productivity…to help make Britain the best place in the world to start and grow a business…and to create a market framework that promotes confidence, opportunity and prosperity for all’¹. Central to this is the reduction of red tape affecting small companies and the introduction of further measures to assist larger companies where necessary².

On closer inspection however, it seems likely that these reforms will increase significantly the burden of regulation for medium and large-sized companies with respect to accounting, auditing and reporting requirements.

The Government has proposed that the drafting of rules governing the content of annual financial statements and reports should be delegated to a new Standards Board. Technical rules to implement the Standards Boards recommendations will be delegated to another body. This three-tier approach of primary legislation, followed by rule-making for the content of reporting documents and then for implementation, presages an uncertain period for companies while the new regime is introduced.

The White Paper recommends the replacement of the Directors’ Report with a short Supplementary Statement and an additional Operating and Financial Review for "economically significant companies".

The Supplementary Statement ensures that companies that do not have to file an Operating and Financial Review fulfil the EU obligation to prepare a "fair review". Its content has yet to be decided and this will probably remain uncertain until the "three-tier" legislation-drafting approach has been completed. The White Paper adds that the Supplementary Statement will require disclosure of matters that would otherwise be in the directors’ report. There is as yet little evidence that, for medium and large-sized companies, producing the Supplementary Statement will be less onerous than producing the directors’ report.

The White Paper seeks to impose increased reporting duties on large private and public companies. It recommends that "economically significant companies" be required to publish an OFR in addition to the Supplementary Statement, though it is up to the company whether they include the Supplementary Statement within the OFR or publish it separately.

An "economically significant company" is defined as one that meets any two of the following three size criteria:

The White Paper estimates that this would cover around 1000 businesses, with an aggregate turnover of £1000bn and a quarter of corporate economic activity in the UK. These companies represent less than 0.1 per cent of registered companies.

The White Paper asserts that companies are increasingly reliant on so-called qualitative assets such as the skills and knowledge of their employees, their business relationships and their goodwill. It proposes that the OFR should include information about plans, opportunities, strategies and risks, relationships with customers and suppliers and a company’s impact on the wider community and the environment. This would be in addition to quantitative information already required, such as the company accounts, historical information, such as the previous year’s financial statements and information about company matters.

Omission of information from the OFR for reasons of confidentiality or political sensitivity is not permitted by the draft Companies Bill. However, the White Paper does ask for suggestions as to what information might be generally excluded on these grounds and how excluded information might otherwise be drawn to investors’ attention.

Auditors will be required to report on the adequacy of the process of preparation of the OFR, compliance with the rules and consistency with information in the financial statements and obtained as a result of the audit.

It is not yet clear whether sanctions for non-compliance will be imposed and, if so, what form these will take, whether specific penalties or public censure. The regime may rely on the negative market reaction to a company which fails to comply as a deterrent.

The Government intends to ask the Standards Board to draw up detailed rules for the compilation of the OFR and will establish an independent group of experts to help provide guidance for directors to decide when an item is material to their company and must be included in the OFR.

Estimates for producing an OFR vary from £5,000 to £50,000. The Government is adamant that £5,000 is the appropriate cost³.

Financial statements are also to be expanded. The White Paper recommends that the Profit and Loss account becomes a wider performance statement that records all gains and losses including revaluations. Additionally it proposes a cash-flow statement subject to audit. This should increase general transparency. But the final decisions are left to the delegated rule-makers who should take account of EU accounting directives.

The White Paper proposes widening the option currently open to listed companies to provide a simplified summary statement in place of financial statements, directors’ report and auditors reports, unless shareholders demand to see the full documents. The new proposal would include a summary of all annual reporting documents and the possibility of making it available to all shareholders will be open to all companies. Once again the Standards Board will produce the specific rules.

The White Paper seeks to simplify accounting requirements for about 15,000 companies⁴ by widening the definition of a small company for accounting purposes to:

• £4.8 million turnover (currently £2.8 million)
• £2.4 million balance sheet total (currently £1.4 million)
• up to 50 employees (currently 50)

Small companies will not have to provide the proposed cash-flow statement, nor consolidated financial statements (if a parent or small group). The Review proposed the principles of a simpler accounting regime for smaller companies based on the Financial Reporting Standards for Small Entities. According to the White Paper the Government intends to adopt this to the extent that it does not contradict EC accounting directives.

The Government had hoped to reduce the costs on small companies that are currently required to audit their accounts because they fall outside the Company Act 1985 threshold, by introducing a less onerous and costly alternative to auditing. Since surveys showed that this was not popular among companies, the White Paper has proposed an increase in the threshold below which companies do not need to undertake an audit, from a turnover of £1 million to £4.8 million. However, the Government is due to review the increased threshold solution in the light of recent research into the effect of the previous increase in the threshold from £350,000 to £1 million in 2000⁵, so there is no guarantee that smaller companies will benefit.

All companies are affected by the Government’s proposals for the filing and laying of accounts. The White Paper reduces the time-limits for filing accounts from ten months to seven months for private companies and from seven to six for public companies apparently due to improvements in technology and the increased rate at which information becomes out of date. It also stipulates that companies that lay their annual accounts and statements at a meeting should be required to do so within ten months.

The right for small or medium-sized companies to file abbreviated accounts has been abolished in order to promote greater transparency and counterbalance accounting and auditing relaxation for small companies. According to the White Paper this should not result in substantially increased costs for firms since normally these companies produce a full set of accounts for circulation to their members but provide less detailed accounts for Companies House in order to withhold certain information from the public domain.

Parent companies of medium-sized groups are currently exempt from providing consolidated accounts. The White Paper suggests abolition of this exemption in light of the other accounting exemptions but is not prescriptive and specifically asks for opinions on this point.

The White Paper’s proposals for quoted companies are indicative of the drive for transparency. It recommends that quoted companies publish their annual reporting documents on the internet as soon as practicable after they have been approved and the audit document has been issued, and at the latest within four months of their year-end. It also suggests that quoted companies should make preliminary announcements of results available to members on the internet. These measures are common practice among large companies, they imply no material extra costs and the information would already be available to the public in hard copies at the company’s registered office or at Companies House.

As listed companies will no doubt be aware, the absence of legislation affecting them is not a sign that they have been overlooked in the passion to prioritise the interests of small companies. The International Accounting Standards Regulation was adopted by the European Council on 7 June and from 2005 onwards will require listed companies to prepare their consolidated accounts in accordance with International Accounting Standards⁶. It is one of a number of post-Enron European accounting measures.

Most of the reporting, accounting and auditing proposals will be backed up by administrative sanctions imposed through the Reporting Review Panel or by the Secretary of State. Deliberately deceptive or misleading statements to auditors and deliberately false accounting may be subject to criminal sanctions.

How far the Companies Bill succeeds will depend on how much time Parliament devotes to it and whether rules for the content of documents and the implementing of legislation can be drawn up and enforced by implementing boards and committees. While small companies stand to benefit from simplified accounting requirements, medium and large companies are to be subjected to increased reporting and accounting duties in the crusade for transparency. However, in the aftermath of the demise of Enron and Worldcom, in an atmosphere of tumbling stockmarkets and mounting accounting and conflict of interest scandals on Wall Street, the need for investor confidence is paramount and the Government appears to recognise this. Moreover, the rather bureaucratic system of legislation-drafting may yield more business-specific laws. But there is little immediate solace for medium and large-sized companies. Even the potential cost and time benefits of having to produce a supplementary statement in place of the directors’ report are uncertain given the lack of specific proposals.

The deadline for responding to the White Paper is 29 November 2002.