The EU accounting directive brings a much-changed small company accounting regime, added complexity and confusion. Liz Loxton investigates

The new EU Accounting Directive brings sweeping changes to the small company reporting regime. However, while European Commission (EC) policymakers seemed to have had the laudable aim of reducing the need for smaller entities to produce overly complex accounts, the new rules are not a farewell to complicated decisions. In fact, they seemingly introduce a degree of complexity and an apparently contradictory approach to disclosure and transparency that will seem wrong-headed to many.

The new rules expand the turnover and balance sheet limits of small companies to £10.2m and £5.1m respectively, opening up the small company reporting regime to around 11,000 more companies in the process.

They also set limits on the number of disclosures that member state governments can require in accounts and stipulate that, providing all shareholders or members agree, companies may file abridged profit and loss accounts and balance sheets.

For practitioners and other commentators, these new parameters introduce problems – practical and professional ones.

Firstly, the lack of a requirement to provide full accounts will worry many, since it may lead to less high quality information being made available. Secondly, the limits on the number of disclosures that member states can mandate seems to run contrary to the need to present a true and fair view.

What is more, with the exception of those organisations that qualify as and elect to report as micro entities, small companies will prepare reports and accounts under an amended FRS 102, using its recognition and measurement approach, which may mean added complexity when accounting on areas such as financial instruments and intangibles.

The whys and wherefores of updating the EU Accounting Directives have been a subject of debate since 2010, says ICAEW’s head of financial reporting Nigel Sleigh-Johnson. “We supported an overhaul of the accounting directive, which was very dated, some went back to the 1970s, and which was very detailed and not always coherent.”

However, while ICAEW argued in favour of shorter principles-based standards, the directive moves small company accounting towards maximum harmonisation across the eurozone and largely restricts what member states can do independently, he says. “We rather felt that what we had in the UK was proportionate and argued that member states should have flexibility to debate their needs in their own countries. All the focus of the debate early on, however, was on country-by-country reporting and transparency issues, so the very important small company accounts regime didn’t get the focus it needed.”

Initially, the directive limited the number of disclosures member states could require from small companies to eight. Post consultation, policymakers made an important concession. Member state governments can require an additional five disclosures, an option that the UK has taken up. Nevertheless, there is disquiet around whether even this new agreed maximum will result in reports and accounts capable of providing a “true and fair” view.

In February, the Financial Reporting Council (FRC) released three exposure drafts including amendments to FRS 102 and a new standard for micro entities to replace the FRSSE, FRS 105. It has also produced guidance on disclosures that companies may want to consider making.

“We’ve tried to be helpful by cross-referencing those disclosures required by legislation with those that [companies] may need to consider,” says Jenny Carter, director of UK accounting standards at the FRC. “We are also encouraging small companies to make a statement of compliance with FRS 102 and any disclosures about first-time adoption of FRS 102.”

As to the potential gulf between sticking to the letter of the law and limiting disclosures to the 13 stipulated by the directive, the FRC can do little more than encourage small companies to take a broader look at the issue. “Each company and its auditor will need to make their own judgement on whether their accounts provide a true and fair view,” she says.

To many, this artificial ceiling on what the FRC and UK government can require introduces a potential problem for accountants and company directors. “There is the risk that companies may face a legal challenge on the information they release – which does happen in small company accounting. And there is a possible risk that you get a deterioration in overall quality,” says Sleigh-Johnson.

Fiona Hotston Moore, partner at Ensors, agrees: “You have this reduced set of disclosures on the one hand but with a true and fair over-ride. My concern is whether this reduced set of accounts will result in reduced quality. I can’t see that the true and fair override will be effective.”

The new regulations allow small companies to produce abbreviated accounts for their shareholders, providing they received 100% shareholder approval for this option to be taken up. These abbreviated accounts will however, says Nigel Sleigh-Johnson, be highly curtailed, providing very much less information than full accounts. They are also not the same as current abbreviated accounts and companies will have to seek consent from shareholders each year to file them. “ICAEW opposed this strongly,” he says. “In deregulation, there is always this assumption that less is better.”

There are, he believes, very real practical implications here for small companies when it comes to raising finance. “Companies that have filed abbreviated accounts with Companies House have had very varied experience when trying to raise finance because there isn’t sufficient information available. There is always the danger that this approach might exacerbate problems around availability of credit.”

As to whether small companies will voluntarily step up their disclosures beyond the mandated 13, in practical terms this seems unlikely. “Generally companies want to get their accounts done. Probably their main focus is their tax bill. They perhaps won’t see the other side of the coin,” says Hotston Moore.

“The BIS consultation suggests that small companies will only have to produce abbreviated accounts. I suspect if approved they wouldn’t file full accounts and that would be a step back,” she says.

The draft FRS 105 gives a standalone standard for micro entities, albeit one that is still based on the recognition and measurement principles of FRS 102, giving small company accounting a consistent UK GAAP flavour. What is proposed will result in quite a limited set of accounts with two financial statements – the balance sheet and profit and loss account. The information within those will be quite condensed. Again, the result is one the financial reporting faculty regards as quite restrictive. “They give very limited analysis and disclosures. This is not an area where we were particularly happy, because again it means reducing the information released,” says Sleigh-Johnson.

And once again, this cut-down version of accounting makes difficulties when it comes to signing off the accounts. “They are deemed to give a true and fair view under the directive, and yet there are virtually no disclosures and limited information. By the standards of most professionals they will not give a true and fair view, and there is probably no challenging that in the courts because it is in the law.”

Micro entities can volunteer more information if they wish and they can also elect to report under FRS102 rather than FRS105. But micro entity reporting, if widely adopted, it is feared, will present only a very small window on activity and performance.

The FRC expects to release a final standard for FRS 105 in July. And the directive will take effect for companies with financial years beginning on or after 1 January 2016.

After that, adopting the standards will be challenging in Sleigh-Johnson’s view. “The directive has simplification at the core but actually there are many tiers and options within it that add complexity,” he says.

And while the smallest companies may choose to take the apparently simpler accounting regime, at the larger end the worries persist that accounts will hamper commercial activity such as raising finance while only apparently alleviating red tape.

All this amounts to a lot of game changes, for a sector of the economy that might otherwise be poised for growth. “With the increase in turnover, some of these businesses can be quite substantial. And it’s another change,” says Hotston Moore. “We keep tinkering particularly at this end of the market and I wonder how helpful that is. This is a sector that should be growing. Companies within it will want to look at raising finance or perhaps acquiring other businesses. Moves that downgrade the quality of their accounting information are not going to be helpful.”

“The EU directive was quite well received. I’m just not sure that preparing a full set of accounts with appropriate disclosures is the red tape holding these companies back.” Liz Loxton

Source: Economic ICAEW