In this episode, we run through the major changes and address some of the concerns expressed by preparers.
Host
Philippa Lamb
Guests
- Debbie Crawshawe, Head of the Accounting and Audit Centre of Expertise, BIST
- Sally Baker, Corporate Reporting & Governance Director, ICAEW
Producer
Natalie Chisholm
Series Lead
Mark Rowland
Transcript:
Philippa Lamb: Welcome back. The government is now going full steam ahead with its modernising corporate reporting agenda with a tight timeframe to deliver sweeping regulatory reform. So what are they planning? What might it mean for preparers of reports?
[Teaser audio] Debbie Crawshawe: What we’re saying is that let’s test each element of the system that we currently have. Let’s make sure that it works properly for UK businesses. Let’s make sure that it’s the most appropriate system that we can have.
[Teaser audio] Sally Baker: There’s definitely a maze of requirements at the moment, and we continually hear about the complexity of navigating those requirements. I think also, it’s worth bearing in mind that the legislation can be quite slow to change. So if you have detail in legislation, it does create a much less agile system.
PL: In this special bonus episode, an expert from the Department for Business Innovation, Science and Trade is going to join us to run through the plan and answer some of the most pressing questions about it. Debbie Crawshawe is head of the Accounting and Audit Centre of Expertise and listening in with me here to explain the implications, Sally Baker, ICAEW’s own Corporate Reporting and Governance Director. Welcome both.
DC: Thank you.
SB: Hello.
PL: So Debbie, this is the broad consultation, isn’t it? The proposals, I think firstly could mean a lot of change for both business and the accounting profession. Should we start with a bit of an overview about the key aims and perhaps the problems you’re trying to address?
DC: Absolutely. So many of the people listening will be aware that a couple of years ago we launched at the Non-Financial Reporting Review, and the aim of this review was to look at our narrative reporting rules and basically tighten them up, get rid of the mess that they’d become. But one of the key pieces of feedback that we received was that for this to really make a difference, we needed to look at the whole of the annual report. And that’s what we are doing. We are looking at the whole of the annual report in an attempt to reduce burdens on business, to streamline the legislation and reduce the complexity that we know is in the framework, and also to make the legislation fit for purpose for the future. The company’s act has been described as analogue in a digital age, which I think is a wonderful soundbite. We know it doesn’t work for today’s economy. We want to address that. That’s what we’re trying to do,
PL: Sally, because I know there has been some concern that this new definition, proposed definition might conflict with the Companies Act?
SB: The first big area in the consultation is looking at the purpose of the annual report and the government is proposing that it is focused on investors and creditors. So it has a relatively narrow focus. We’ve heard some people that think that the purpose of the annual report should actually be for wider stakeholders. I think that there is perhaps a lack of appreciation that the investor and creditor focus does actually align with the enlightened shareholder value concept that came into the Company’s Act in 2006. So it’s getting that understanding across. I think that the two don’t conflict.
PL: So, not such a narrowing as people might imagine?
SB: Yeah, quite.
PL: Okay.
DC: And just to add, I think there’s an important distinction to be made here between director’s duties, which are broader about the running of the company and the annual report. The annual report is just one part of what directors have to produce, what a company has to do. The two are different. We’re not proposing to change the director's duties. What we’re doing is we’re saying that the annual report, the document that has to be produced once a year, has lost its way.
PL: I think that’s usefully clarified that.
SB: Yeah. So there’s no plan to remove Section 170.
PL: Should we move on to the changes around true and fair? Because I think the proposal is to remove the need for micro entities and SMEs to meet the true and fair concept. Instead this is about preparing accounts that simply comply with specific accounting standards, is that right? What’s the thinking there?
DC: Let’s just go back a step. This is a true consultation. We are not coming out with something that government is then looking to implement straight away. We want to hear your views. We want to provoke that discussion, and the consultation is deliberately provocative in places in order to generate that discussion.
PL: Okay. That’s good to know.
DC: Now, in that context, let’s think about how true and fair works in the company’s act. True and fair applies to all companies, but micro companies have already what’s called a true and fair presumption. That means their accounts are presumed to be true and fair if they comply with very limited requirements in the act. Everyone knows that those accounts don’t result in a true and fair view, and that’s why we have the true and fair presumption. In effect, what they’re doing is complying with the standard. What we’re saying is, let’s test whether that model is also appropriate for our SMEs. Is it sufficient for SMEs to just comply with a standard or is this something extra that true and fair brings, which is appropriate for SMEs? It’s not talking about all companies, it’s just that population.
PL: Well, Sally, Debbie says she wants feedback, so what do you reckon?
SB: I think we’re starting to hear some concerns around this partly because of the proposed expansion of the SME regime which would actually bring in quite a large population of companies into that SME category. So I think there’s further discussion to be had.
DC: That’s exactly what we want. We want to test what true and fair means in the context of these companies. The consultation is serving its purpose. We want to be pushed back in places. This isn’t about criticising what the government has put out. This is about the government starting a conversation and that conversation with stakeholders is absolutely vital for us to get to the right answers. Government doesn’t have all the answers here. We need stakeholder input in order to reach that and particularly in relation to financial reporting. The model that is suggested is just a model. It’s not the model.
SB: I think it’s really important as well that in order to end up at the right answer, we push the boundaries and discuss going too far in order to come back and work out where we should be drawing the line on certain things.
PL: Yeah, okay. Robust debate is what we’re looking for here. The plan is to remove all detailed financial report requirements from the companies in 2006?
DC: Absolutely. So at the moment we’ve got a bit of a mess. Let’s face it. When you look at what detailed reporting requirements a company is required to comply with, if they’re doing company’s ACT accounts, they have to look at the act, they have to look at regulations, they have to look at the accounting standards. Now, it’s fair to say that those elements don’t fit together that well, and we want to address that. We don’t think that the act is the right place for detailed obligations. It would be much simpler for everything to be contained in one place. And we think that the appropriate place for that detail is accounting standards. That’s what we’re trying to achieve.
SB: Yeah, there’s definitely a maze of requirements at the moment and we continually hear about the complexity of navigating those requirements. I think also it’s worth bearing in mind that the legislation can be quite slow to change. So if you have detail in legislation, it does create a much less agile system. That's a much less agile framework. So by having some of the details sitting in the accounting standards, then the UK can be much more responsive to change.
PL: Now, some of the most significant changes around medium sized companies, aren’t they? And whether they should effectively be merged with small companies into a single SME category, that would be a big change?
DC: It would, absolutely. This is testing whether it’s time to align the way that the act works with the way that we think about the economy, both within government and externally. It’s only in the Companies Act that you hear this distinction between small companies and medium companies. Everyone else talks about SMEs.
PL: So, Sally, do we know what sort of turnover range is being proposed?
SB: Based on the current thresholds that would create an SME category for companies with turnovers between £1 million and £54 million.
PL: That is a broad range?
SB: That is a really broad range. Again, I think we are starting to hear that perhaps that’s too broad and that there is a whole range of companies from really quite small companies with £1 million and a little bit over, compared to a £45 million turnover company, that they can be really quite complex, they will have a lot of external finance, and that there are fundamental differences between those types of companies. That perhaps needs to be thought about in the context of reporting.
DC: I think you’ve hit on a really important area of the consultation because the company’s act applies to all companies, whether that’s really tiny owner managed micro businesses, right up to the largest PLCs. The key question for us in relation to this is where do we draw those boundaries? Clearly we can’t have the same regime applying to all of those companies. We have one model where we draw boundaries at certain places. I don’t think that’s the best one that we could have. We are proposing another model of SMEs within the consultation document, but that might not work either. We want to understand where’s the best place to have those step changes in reporting obligations.
PL: What would it mean for accounting standards?
SB: So, in the consultation there is a discussion around a change to four main accounting standards. So we would continue with UK adopted international standards for listed companies. So that wouldn’t change. There would then be a UK accounting standard for large companies. There would then be an accounting standard for the new SME category and then a UK standard for micro entities. So that’s actually creating effectively another accounting standard into the system and that brings challenges and cost. So that’s another big area that’s up for debate.
DC: But I would also say that I think it brings opportunities as well. So at the moment we have FRS102. And then we have FRS102 1A, which is a reduced disclosure framework available to small companies. Now, it’s important to recognise the limitations of that. It’s a reduced disclosure framework, which means that small companies have to use the same recognition and measurement criteria that there is in FRS 102. If we move to a model where there was an SME standard that would give the ability to have different recognition and measurement criteria for those smaller entities. Now, one of the messages that I’ve been hearing, not just in the UK but actually globally, is that there is a group of companies for whom IFRS 15 and IFRS 16, so the new standards on revenue recognition, the new standards on leasing, are actually really very difficult to apply. Now, having a new framework where we have a standard specifically for SMEs gives us the flexibility to say, is it actually necessary for these companies to have these complex models?
SB: That’s going to create a bit of a problem though, because we’ve got the periodic review amendments coming in from 2026. So there are companies that are preparing accounts for this year with those new revenue and leasing requirements. If we then move to a simplified SME regime where perhaps we don’t have the IFRS 15 and the IFRS 16 models in the UK standards, then those companies have potentially had to apply them and then come backwards.
DC: This is why it’s so important to have the discussion. We’re not saying that this is what we are definitely going to do. What we’re saying is that let’s test each element of the system that we currently have. Let’s make sure that it works properly for UK businesses. Let’s make sure that it’s the most appropriate system that we can have. There are a lot of challenges with any change, but let’s really test the system to make sure that it’s worth sticking with what we’ve got, and that system actually provides the benefit that we need to create within the financial reporting framework, not just now, but for the next decade, for the next generation.
SB: I think it’s fair to say that we are hearing support for simplified recognition and measurement as well as reduced disclosure, and that therefore section one A is not the most favoured standard outta the existing suite that we have available. And it’s also worth noting that the Financial Reporting Council who set the UK accounting standards have done some fantastic work in terms of taking IFRS 15 and IFRS 16 and making them proportionate for smaller entities within the types of entities that were applying FRS 102.
DC: But also important to recognise that the types of entities that apply FRS 102 is an even broader range than what we were talking about under the SE regime.
PL: I’m going to move us on to, I think, what’s one of the biggest proposals, isn’t it? The idea of increasing the audit exemption threshold of that £54 million, wasn’t it Sally, £54 million turnover level?
SB: That’s correct, yeah.
PL: That came up in our new sister podcast, actually, The Audit Report. Interestingly, some of the auditor guests on that episode, they did have concerns about the medium sized end of the market. I think they were worried about the fact that medium-sized entities, they can have a big footprint. So if things go badly, the impact could be severe. How would you respond to that?
DC: What we want to do is really test the value of audit and the value of assurance in that space of small companies, medium sized entities. At the moment, we have an exemption available for small companies from audit. However, we estimate that only about 50% of companies actually take that up. So clearly there is something about the audit framework that means that small companies, even though they could avoid these costs, still go down the route of having an audit. We’ve also heard that the main reason that they have an audit is because their banks require it. Now, when we’ve spoken to the banks, one of the messages that’s come back to us has been, “ We require something. We are not sure we require a full audit.” But that’s the only product that’s available on the market now. So we want to test the whole system. We want to say within our SME population, most of those businesses are owner managed. So it’s not that annual report is reporting to external shareholders. So, what is the value of that audit report for those businesses and for creditors? That’s really what that question is designed to provoke. It’s also raising a question of whether there is space in the market for an alternative assurance model that doesn’t go as far as being a full audit, but is sufficient to give an assurance that things are, yeah, they’re okay in the business.
PL: And meet the needs you’ve described?
DC: Yeah, and meet those needs.
SB: Yeah. There’s an opportunity there isn’t there, in terms of creating an alternative potentially, to audit. I think there are discussions around what’s available at the moment and the fact that assurance in some cases will be a much lower level compared to audit and therefore it’s about trying to work out what could be available in the future that maybe isn’t a full audit, but is still robust enough to provide that credibility and that assurance to the users of that information.
PL: Interesting territory.
SB: Very interesting.
PL: So the consultation is not just about financial reporting and audit, it is about narrative reporting too. What are you proposing for the strategic report, Debbie?
DC: With the strategic report at the moment, the company’s act is quite prescriptive in what it requires in the strategic report. Essentially government is saying, we, government, believe that these things are important to all the companies within scope of producing a strategic report. We are saying we don’t think government is best placed to make that decision. We want to put the power in the hands of companies and directors to be able to report on those things that are important to them. This is a really key element of the proposals within the strategic report. We are not saying don’t report on employees, we are not saying don’t report on the environment. What we’re saying is think about the things that are really important to your business and report on those elements.
SB: That comes back to that first question around the purpose and the materiality filter of thinking about investors and creditors as the primary user and making sure that you are providing the material information that they need to be able to make decisions.
PL: But there is a baseline?
DC: The baseline requirements are to provide information about the company’s business model. So this is about what the company does, how it generates value. We’ve then got a requirement to provide a performance review. So what’s the company done in the last year? What’s the key elements of its performance? We’ve then got a requirement about resources and relationships. Now this is considering what are the things that a company relies on in order to generate the value? What are the resources and relationships needed in order for that business model to actually work? We’ve then got company strategy. This is the main aims and plans for sustaining and developing the business model. Then finally, we’ve got risks. Risks is a critical part. What are the risks facing the business and how is the company managing those risks? Then finally, we’ve got risks and opportunities. What are the risks and opportunities facing the business? And what’s the company doing to manage those risks and opportunities?
PL: Sally, what are you thinking? Because external environment’s not on the list, is it? But it gives the international
SB: standard? So internationally, we have the practice statement on management commentary, their terminology for narrative reporting. That has a very similar list, but it does include the external environment. Again, we have heard in the debate that we’ve had so far that perhaps that should also be on the government’s list of baseline.
PL: I think you’re also testing, aren’t you, whether strategic reporting is something that should only be required of public companies?
DC: We are, and that’s deliberately provocative to generate that debate and discussion that I’ve mentioned before. What is the value of narrative reporting when a company doesn’t have external shareholders?
SB: We’ve definitely heard that the narrative reporting is there to provide the context to the financial statements to provide that narrative and that story. I think this again, could well be one of the areas, like you said, Debbie, that is provocative and maybe a step too far.
PL: Limiting it to public companies?
SB: Limiting it to public companies. There are views that we are hearing that there is definitely value for the larger private companies to be providing some, some narrative, potentially maybe not the whole suite of narrative reporting. So again, it’s that proportionality as you move up the scale and thinking about that because otherwise you create quite a cliff edge between the private companies and the public companies, and that there is a big step for them to go from one to the other if they then are not used to doing this type of reporting and then suddenly need to do that type of reporting.
DC: This is where the conversation is so fascinating because we’ve got a model at the moment where we’re requiring reporting, narrative reporting of private companies. But have we really had that discussion previously about what’s the purpose of that? What does it really serve? What does it bring to the table? That’s what we’re doing by opening up these conversations, really getting people to think broadly, think deeply about some of those really fundamental questions.
SB: It’s thinking about the objective of the different parts of the report underneath that overarching purpose. So we have that purpose for the whole annual report. Then each section within the annual report should have its own objective that it’s achieving in order to meet that purpose.
PL: Am I right in thinking sustainability reporting is not in the proposals?
DC: You are right, yes. The modernising corporate reporting document does not include the plans that government may have in relation to sustainability reporting.
PL: Is that a surprising emission?
SB: It is surprising. I think a lot of people would’ve liked to have seen a more integrated approach and sustainability reporting, it’s an area where companies need clarity on what’s going to be happening, and we need to be driving that forward. So to be missing it from the consultation when the consultation is looking at the entire annual report does feel like a bit of a black hole and a missed opportunity.
PL: Yeah, Debbie, is the door closed on that?
DC: No, absolutely not.
PL: Okay. There’s a lot more we could talk about. I think I’d like to close by talking about distributable profits because you’re proposing this new regime, aren’t you, around the legality of dividends? Talk us through it.
DC: At the moment, within the company’s act, we’ve got the concept of capital maintenance.
SB: Really complex.
DC: It is really complex. It’s become more complex over time. Capital maintenance was a concept that I think worked well when accounting standards were simple, when business models were simpler than we see today. As accounting standards have become more and more complex, I think that the reasons for remaining with capital maintenance as a concept have become less strong.
SB: There’s an international angle as well here, in the sense that the UK has this very complex regime that most other countries don’t have, and therefore it reduces our competitiveness from that perspective.
DC: I agree, Sally. Absolutely. With capital maintenance, what we’ve got is a very complex series of rules that are capable, quite frankly, of gaming. They’re capable and in some cases they’re actually promoting the use of financial engineering. And that financial engineering in order to create distributable profits, is not leading to the result that we want. This is saying what do we actually want to achieve from a dividend regime? We want companies to only pay out dividends that they can afford to pay out. That isn’t going to affect their ability to continue in the future. That aren’t going to affect their ability to operate the same business model or their plan strategy in the future. It’s forward looking considerations. It’s not about gaming the profits, it’s not about applying these very complex rules to get to this number of distributable profits that you are then legally allowed to pay out.
PL: Might there still be concerns around policing?
SB: I think there’s concerns around policing. I think there’s also concerns, again, at the smaller end of the market because actually at the smaller end of the market, the current regime perhaps isn’t so problematic as it is at the larger, more complicated end. And a question for Debbie, is there scope to perhaps have the two regimes alongside each other?
DC: So this is fascinating because this is something that’s come up in the in stakeholder outreach. I think it’s come as a surprise to many of us that there’s been so much pushback at the smaller end of the market. But when you think about what smaller companies face, they face that simple business model. They face simpler accounting standards that they need to apply in order for their accounts to represent their business model. So is there a world in which we could have a distributable profits regime applying to the smaller end of the market while having a solvency regime applying to those companies that are more complex? Now clearly we don’t want to run a system where companies are able to game the two approaches. That’s absolutely not what we want to end up with.
SB: Then does that introduce cost as well into the system in terms of maintaining those two systems, maintaining the capital maintenance, guidance, et cetera? So there’s again, quite a bit to think through in terms of those options.
DC: There is, but could we have, for instance, almost a one-way door? So the smaller companies for whom they’re saying. Actually, this works for us. We know what our distributable profits are because we don’t have any profits that aren’t distributable. Our business models are simple enough that all of our profits are distributable. But could we have a regime where it could be subject to a shareholder vote that companies are then able to enter into the solvency regime, but then once they’re there, they don’t go back.
PL: Sally?
SB: But I also think in order to have answers around this, we need more detail. It’s quite difficult to debate and test, which is the right way forward without more detail of how a solvency regime would work in practise, what those checks and balances would be. So that’s another thing that we’re starting to hear, but my understanding is any change here wouldn’t be in the short term, it would take quite some time.
DC: Absolutely. This is one of the areas of the consultation document where we need primary legislation and the proposals are very green. We want that discussion, we want that debate. But because we need the primary legislation, this isn’t going to be a quick change, but we think that now’s the time to have the debate again. I’ve been around long enough to know that this debate comes around every decade or so. I think it’s now the right time to have the debate again and try and reach an answer on this.
PL: It’s a big aspiration, isn’t it?
DC: It is, absolutely.
SB: The whole thing’s a big aspiration.
PL: Yeah. As you currently understand it, Debbie, next steps from here in the timeframe?
DC: So it’s important to recognise that this consultation is a true consultation. We will be taking into account feedback. This isn’t something that government is suddenly going to come out with the proposals that it’s going to implement straight away.
PL: When does that consultation end?
DC: So the consultation ends on the 30th of November. We will be looking at all of the responses. We’ll be taking account of all the feedback that we received during the outreach events, and we’re doing a lot of outreach events, and we will be preparing a government response, taking into account all of that feedback, and from that, looking at which proposals we take forward and how we take those forward. So in relation to how we take them forward, that will be a mixture of primary legislation, secondary legislation, and some non legislative measures as well. So until we see that feedback, we won’t really know what we want to take forward and how we need to take it forward.
SB: There may be concerns if things move too quickly though, and things aren’t subject to further consultation. So I think that needs to be considered.
PL: Because you have just completed a member’s views survey, haven’t you on this?
SB: We have, yes.
PL: Did you get a good response on that?
SB: We’ve had a very strong response on the member survey, and that will be giving us lots of evidence to put into the final consultation response that we submit. We’re holding lots of debates around the proposals, meetings and working groups and using every forum that we can think of to gather evidence. So, the member survey is just one part of that outreach, but we’ve had a huge uptake in that survey.
PL: There’s lots of opportunity for members to get involved with if they want to?
SB: There was definitely opportunity for members to get involved. We’ll be covering it at the annual conference on the 16th of October. I should be talking to Debbie there. We will definitely be asking for lots of opinions from delegates there and all the opportunities in terms of outreach will be on our website. So head to ICAEW.com/MCR and opportunities for members to contribute will be outlined on the website.
PL: Okay, that’s the place to go. That’s really helpful. We’ll link to that in show notes so that people can find it readily. Thank you both very much indeed.
SB: Thank you.
DC: Thank you.
PL: For the accountants listening, remember to log your listen to this podcast to CPD. Just click on the link in the show notes. In our next episode, we’ll be recording at ICAEW’s annual conference, interviewing speakers and delegates about the biggest challenges facing their businesses and how they’re tackling them inside their own organisations. Thanks for being with us.
