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What the new EU accounting directive means for small firms

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1st Jul 2013
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On 12 June the European Parliament adopted the revised accounting directive that implements the European Commission's Responsible Business package. Steve Collings explains the implications for businesses and their accountants.

The main objective of the new accounting directive (58pp PDF) is to reduce the administrative burden for small companies and, to a certain extent, improve the quality and comparability of the information disclosed in their financial statements.

The current European Union accounting directive for individual financial statements has been in place since 1978 and the directive governing consolidated financial statements has been in existence since 1983. Together these two documents - known as the fourth and seventh directives - govern the way in which financial statements are prepared, including the form and content.

The new directive essentially combines and improves the fourth and seventh directives around the principle of ‘think small first’ to help both preparers and users of financial statements. Supporters argued that merging the two directives would bring clarity, consistency and coherence to the accounting framework for unquoted companies - and save a lot of cross-referencing between directives. 

The European Commission (EC) acknowledged that during the past 30 years, amendments to the fourth and seventh directives brought in new disclosure requirements and valuation rules, particularly in detailed provisions on fair value accounting provisions. The commission admitted these amendments increased complexity and regulatory burdens for companies.

Where financial statements are concerned, the EC said that, in the current form, the fourth and seventh directives make financial statements less comparable across the EU, with small and medium-sized entities suffering the most. Many in our profession will say “my small clients don’t have anything to do with the EU” or “who is going to compare my client’s financial statements with another entity’s in the EU?” The commission claimed that as small companies grow bigger, they will undoubtedly have more involvement with other countries in the union. 

With its ‘red tape challenge’ the UK government has been particularly keen to reduce the burden on small companies. The actual impact of the new directive on small UK companies is currently unclear and will be explored in future articles. For the moment, however, UK accountants are concerned that the European Commission’s simplifications will render financial statements meaningless and undermine the true and fair view. The UK professional bodies are working hard to ensure that this outcome does not come to pass. 

The new directive mandates each member state to make a distinction between those companies which are small and those which are large. In the UK we achieve this by way of turnover, balance sheet total and number of employees. For the purposes of the new directive, small companies will be those with fewer than 50 employees, a turnover of not more than €8m and/or a balance sheet total of not more than €4m.

Member states may also use thresholds for turnover of up to €12m and a balance sheet total of up to €6m. Companies that are classed as ‘micro entities’ have also been incorporated into the new accounting directive and a micro entity is one with less than 10 employees, a turnover of not more than €0.7m and/or a balance sheet total of not more than €0.35m. Such micro entities are also afforded the same level of protection by the new directive as small companies with such companies being able to prepare a very simple balance sheet and profit and loss account with virtually no notes to the accounts if the member state so wishes. 

The EC’s ‘think small first’ approach essentially says that more companies will be considered ‘small’ and therefore will prepare profit and loss accounts, balance sheets and related notes that are proportionate to their size as well as the information needs of users and the EC claim that more than 90% of EU companies will fall into the category of small for accounting purposes. The EC go on to say in their impact assessment that financial statements notes will also include between eight and 13 items as opposed to 14 and 24 notes (or more in some cases) as is the case today. There will also be no requirement to specify ‘extraordinary items’ (although in the UK, FRS 3 defines ordinary activities so widely that all our extraordinary items have disappeared and are referred to as ‘exceptional’ items). Such exceptional items will be reported, instead, as a simple explanation in the notes to the accounts, though I am not sure preparers of financial statements will view this as a significant simplification. 

A key feature of the directive is the fact that it reduces and limits the amount of information that small companies will have to provide in their financial statements - notably in the notes to the financial statements. If the UK were to take the directive and adopt it forthwith small companies would only prepare a balance sheet, a profit and loss account and notes which would only be prepared to satisfy regulatory requirements. There is an option within the directive which permits member states to allow small companies to prepare abridged balance sheets and profit and loss accounts and small companies will still be entitled to provide more information, or additional financial statements (such as a cash flow statement) should they so wish. The fees paid to accountancy firms has been mentioned in the EC’s Explanatory Memorandum and they acknowledge that companies operating in member states that the savings they are setting out to achieve at company level will stem from a reduction in fees paid to accountancy firms with the negative impact on such firms only being marginal.

However things are not as simple as merely rushing to adopt the new directive tomorrow. The directive will be adopted by the European Council and published in the Official Journal. At this point, the Department for Business, Innovation and Skills (BIS) will more than likely launch a consultation and it will be then that we will have a better idea of when Companies Act 2006 will be amended and how.

Conclusion

The new directive has largely been welcomed, but not without some reservations. Certain critics have alleged that if the UK does adopt the new directive in its entirety, it will result in financial statements that are misleading, watered-down and fail to give a true and fair view - something that has been enshrined in the Companies Act for many years.

There are going to be substantial issues in the UK that will need to be considered, so this is likely to take some time - in particular a review of the FRSSE will have to be undertaken insofar as disclosure requirements are concerned. 

Steve Collings is the audit and technical partner at Leavitt Walmsley Associates and the author of ‘Interpretation and Application of International Standards on Auditing’. He is also the author of ‘The AccountingWEB Guide to IFRS’ and ‘IFRS For Dummies’ and was named Accounting Technician of the Year at the 2011 British Accountancy Awards.

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Old fat furry cat-puss
By bagpuss1968
03rd Jul 2013 13:16

Possible use of €6m (B/S) & €12m (turnover) limits....

Having read Article 3 (page 10) of the directive, I couldn't decide which type of entity the paragraph half way down the second column was referring to (regarding the increased limits of €6m and €12m).

Could anyone help me out?

Many thanks

 

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By The Black Knight
16th Jul 2013 12:43

one things for sure

One things for sure they are about to loose billions as are ordinary businesses and consumers.

I am always right! Unfortunately

Kassandra

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By The Black Knight
16th Jul 2013 14:35

Kassandra was King Priam of Troy's daughter. (K from the Greek, not later C from the latin)

Had the gift of true prophecy and the curse that no one would believe her.

The modern use of Cassandra is a merchant of doom also to be disregarded as getting in the way of progress.

 

 

 

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