Many AAT students and members work for small companies and the way in which such companies will report their financial information is set for change in 2016. 

Some of the changes brought about by the revised Companies Act 2006 are welcome; others might need some getting used to but it is important that AAT members and, in particular, Members in Practice, fully understand the impact of the new reporting regime.

This is the first in a two part series of articles which examines some of the main changes that AAT members and students need to understand as it will invariably affect most companies in the UK and Republic of Ireland.  This first article examines some of the legislative changes brought about by the revised Companies Act 2006; and the second article in the series will take a look at the effect the legislation has had on financial reporting for small and micro-entities.

UK Generally Accepted Accounting Practice (UK GAAP) is undergoing a significant period of change as the effects of FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland begins to tighten its grip.  Eventually by the end of 2017 all companies in the UK and Republic of Ireland will report under a framework which is based on International Financial Reporting Standards and for some companies the transition to the new frameworks will start earlier than others.

Revisions to the Companies Act 2006

Many AAT qualified accountants may be aware that the Companies Act 2006 has seen changes being made to it by the Department for Business Innovation and Skills (BIS).  The Companies Act 2006 had to be changed to reflect the provisions in the EU Accounting Directive (the Directive) which essentially overhauls the way in which financial statements for small and micro-entities are prepared.  In addition, the Directive also restricts the levels of disclosures that are made within the financial statements themselves and regulators in Members States (for example the Financial Reporting Council in the UK) cannot mandate additional disclosures over and above the requirements of the revised legislation because the Directive prohibits this.

The revised Companies Act 2006 received Royal Assent on 26 March 2015 and became effective on 6 April 2015.  It applies to accounting periods which start on or after 1 January 2016 but an early-adoption clause has been built into the legislation which allows a company the option of early-adopting the provisions of the revised Companies Act for an accounting period starting on or after 1 January 2015 but before 1 January 2016, if the directors so wish.  The reasons why a company might want to early-adopt the revised Companies Act 2006 will become apparent in the next section.

Revised size thresholds

One of the most notable changes brought about by the revised Companies Act 2006 is the increase in size thresholds which define a small, medium-sized or large company or group.  The table below outlines the revised size thresholds:

There are some points to note in relation to the above table as follows:

• The term ‘balance sheet total’ is fixed assets plus current assets. Care must be taken not to use net assets because this is after deduction of liabilities (balance sheet total is also referred to as ‘gross assets’). The average number of employees is the average employed throughout the year, not the actual number employed at the year-end.  This is a Companies Act 2006 requirement and the calculation is as follows:

• 1. Find for each month in the financial year the number of persons employed under contracts of service by the company in that month (whether throughout the month or not).
• 2. Add together the monthly totals.
• 3. Divide by the number of months in the financial year.

The size thresholds in the above table have increased considerably (indeed a small company’s turnover has gone from £6.5 million to £10.2 million).  BIS have said that by taking advantage of the maximum size thresholds permitted by the Directive, this will allow approximately 11,000 businesses to drop from medium-sized classification under the previous Companies Act 2006 to small under the revised Companies Act 2006.  This will allow such companies to apply the provisions in the small companies’ regime and allow them to make less disclosure in their financial statements than would otherwise be the case.  Care, however, must be taken in this respect.

Where a company that would have been classed as medium-sized is now eligible to be classed as small under the new size thresholds, it can early-adopt the new Companies Act 2006.  For example, a company might have a year-end of 31 December 2015 and now qualifies to be classed as small and the directors might decide to early-adopt the revised Companies Act 2006 and use the small companies’ regime (as they could early-adopt the legislation for accounting periods starting on or after 1 January 2015 but before 1 January 2016 if they wish).  What the company must not do is apply the requirements of the Financial Reporting Standard for Smaller Entities (the FRSSE) in its 31 December 2015 year-end accounts.  It must, instead, apply the provisions in FRS 102, Section 1A Small Entities (in other words it must adopt the new suite of standards).  Also, the company would not be able to claim audit exemption because whilst the audit exemption thresholds have been increased to match the small company thresholds, the audit exemption thresholds cannot be early-adopted.

Reduced disclosure requirements

As mentioned earlier in the article, the Directive restricts the ability of regulators from mandating any additional disclosures in the financial statements of small and micro companies than those required by the Directive.  Some of these mandatory disclosures will not apply to every small company and therefore some companies might have fewer legally required disclosures than others.  However, an important point to emphasise where the disclosures are concerned is that the financial statements of a small company must still give a true and fair view as this is a legal requirement in the UK.  As a result, the directors of a small company must review the financial statements as a whole and determine whether or not they give a true and fair view.  Usually the directors will seek the advice of their accountant to make this judgement call for them; but where the financial statements need extra disclosures to achieve a true and fair view then they must be made.  A typical example would be in relation to going concern.

Where there are material uncertainties relating to going concern, then under the FRSSE a company would be expected to make some disclosures to achieve a true and fair view.  Under the new regime, this would still be expected despite the fact that going concern disclosures are not a legally required disclosure.  There is still a requirement in UK company law to produce financial statements that give a true and fair view.

In addition, many publications cite a minimum of 13 disclosure requirements.  Whilst this is true, the 13 disclosures should be viewed as ‘topics’.  This is because these 13 ‘topics’ essentially cover several areas of the Companies Act 2006 and are as follows:

• 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    (along 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 disclosures

The Financial Reporting Council have mapped the above 13 disclosure requirements to the various areas of the Companies Act 2006 and, in fact, there are 39 disclosure requirements that are required by law contained in Section 1A of FRS 102 that small companies will have to consider.  Section 1A of FRS 102 will be examined in more detail in the next article in the series.

True and fair view

The requirement for small companies to produce financial statements that give a true and fair view has not changed in the revised Companies Act 2006 and therefore it is still a legal requirement for small companies.  In recognition of this, the Financial Reporting Council have included a further five ‘encouraged’ disclosures in Section 1A of FRS 102 which reporting entities must consider making.  These have been included because the Financial Reporting Council recognise that the mere application of the legally required minimum might not be enough to give a true and fair view and more disclosures will therefore be needed to achieve a true and fair view.

The five encouraged disclosures are as follows:

• A statement of compliance with FRS 102
• A statement that the entity is a public benefit entity (if applicable)
• Going concern disclosures in the event of a material uncertainty relating to going concern
• Dividends paid/payable
• Transitional information explaining the impact of the transition to FRS 102 on the small company’s financial position and    performance

For micro-entities, the true and fair concept is presumed in the legislation.  In other words, if the micro-entity prepares its financial statements in accordance with the legislation, then those financial statements are presumed to give a true and fair view. Therefore, the directors will not have to consider any additional disclosure requirements.  The legally required disclosures for a micro-entity are:

• Advances, credit and guarantees granted to directors as required by section 413 of the Companies Act 2006.
• Financial commitments, guarantees and contingencies as required by regulation 5A of, and paragraph 57 of Part 3 of    Schedule 1 to, the Small Companies Regulations.

The above disclosures will be made at the foot of the micro-entity’s balance sheet.

Conclusion

The changes made to the Companies Act 2006 have had a significant impact on small (and micro) entities.  However, some of the changes made will result in more responsibility being placed on the directors (and accountants) in ensuring that the financial statements still give a true and fair view for small companies.  The next article will examine the principles of the new financial reporting regimes for small and micro-entities as the legislative changes have had a direct impact in the way that small and micro-entities will prepare their financial statements.

Steve Collings is the audit and technical partner at Leavitt Walmsley Associates Ltd.