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Control of accounts by shareholders

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Dear Accountingweb members

I know I risk the wrath of possible ridicule but I am going to ask my question regardless.   It has become quite heated and I need resolution please

I have prepared the accounts of a small limited company.  The shareholders are also directors of 2 other much large companies in the same industry

There was very little in the way of cost-of-sales.  All other transactions were (sales and overheads etc) were accurate but it transpires that most of the cost-of-sales for this company were being absorbed by the other companies.  The GP was ridiculous -  like 70 - 80%

I insisted that we make a provision in the statutory accounts for COS.  The shareholders are objecting.  This leaves an unreal situation which I believe is against the spirit of Company Acts.  The counter-argument is that Company Acts are primarily concerned with the protection of shareholders and it this case it is the shareholders insisting I do not make this accrual.  Company Acts though are also intended to protect creditors and everyone else who has dealings with a company.  It is after a separate entity from the shareholder.  If nothing else the company will incur more corporation tax than necessary

Can I please ask the opinion of Accountingweb with, if possible, the legislative reference that might support my views

Thank you

I .   

 

 

 

 

Replies (32)

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By WhichTyler
15th Feb 2020 09:11

Are the other companies aware that they are subsidising this one? If not it looks like fraud, as the directors are enriching themselves at the expense of the larger cos shareholders. And if it's fraud, or you suspect it is, then follow the ML regs...

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Replying to WhichTyler:
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By aceman2
15th Feb 2020 09:55

Hi,

Thanks for responding.

I am satisfied there is no financial enrichment. I just feel that this 'manipulation' does not reflect the 'true' position of the company.

Is there any policy or legislative ruling that would support my view?

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By lesley.barnes
15th Feb 2020 09:36

No one is going to ridicule you it's a completely valid and interesting question. Are the shareholders of the smaller company also the sole shareholders of the two larger companies that are subsidising the small company? I'm trying to establish if there is any undue enrichment, what is the financial impact of what they are doing other than Corp Tax being paid by small co and being reduced by big co. Is small co VAT registered?

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Replying to lesley.barnes:
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By Accountant A
15th Feb 2020 11:50

lesley.barnes wrote:

No one is going to ridicule you it's a completely valid and interesting question.

The question isn't stupid but the idea of "accruing for an amount that will bring the GP in line with 'normal' returns for the industry" clearly is.

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By aceman2
15th Feb 2020 09:50

Thank you for your kindness Lesley

The shareholders of the company are also main (or sole) shareholders of the other companies so are all very aware of what is happening.

My concern is my decision on insisting that the GP is correct. The actual amounts of COS are unknown so I am accruing for an amount that will bring the GP in line with 'normal' returns for the industry

Thanks

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Replying to aceman2:
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By Matrix
15th Feb 2020 09:55

Who prepares the accounts for the other entities? What makes you think your provision would be deductible for tax?

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Replying to Matrix:
RLI
By lionofludesch
15th Feb 2020 10:01

Matrix wrote:
What makes you think your provision would be deductible for tax?

Is it a provision or a creditor ?

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Replying to lionofludesch:
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By Matrix
15th Feb 2020 10:13

How can it be a creditor if no inter company charges have been agreed with the other companies who are bearing this company’s costs? I would ask to discuss with the other accountants since these companies could be incorrectly claiming a deduction for these costs.

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Replying to Matrix:
RLI
By lionofludesch
15th Feb 2020 17:51

Matrix wrote:

How can it be a creditor if no inter company charges have been agreed with the other companies who are bearing this company’s costs? I would ask to discuss with the other accountants since these companies could be incorrectly claiming a deduction for these costs.

Do we know whether there are any ?

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RLI
By lionofludesch
15th Feb 2020 10:01

Key to this is the answer to the simple question "Why?".

There could be a VAT fraud going on, as Lesley implies or the directors could simply be stealing goods from the larger companies.

Prima facie, it looks decidedly dodgy and I'd want some answers before I signed these accounts off.

An SAR is a strong possibility, depending on your assessment of the position.

Incidentally, I agree with Lesley. This is a jolly interesting question compared with the usual my-tax-bill-is-too-high carp that seems prevalent these days.

EDIT - my reply seems to have been overtaken by other replies. However, I'd still want to know why. I'm not sure that there's anything to prevent one entity selling goods cheap to another but I'd need to know who gains and who loses.

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By Wanderer
15th Feb 2020 10:31

Section 393 of the Companies Act 2006 requires that the directors of a company must not approve accounts unless they are satisfied they give a true and fair view. Additionally Section 396 is the underlying true and fair requirement.

Appreciate you are unlikely to be carrying out an audit however you have a professional obligation not to be associated with assisting in the preparation of accounts which don't give a true and fair view.

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Replying to Wanderer:
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By aceman2
15th Feb 2020 15:31

Hi - thank you for your reply.

I believe this is what I was searching for. There were suggestions of malpractice or possible fraudulent activity.

I know this not to be true. I believe it was to show the company in a better light. to not show c-o-s is a bit extreme though I admit LOL.

It is the building industry and identification of costs can often be 'difficult'. I know that there have been elements of 'absorbing' costs by the two companies whose directors common interest in this company.

I need to make some attempt to quantify the costs not entered. What else could I do than assume the gross margin is similar to other companies in this field and then make a provision to cover?

You have given me the rationale that I was unable to articulate. does it give a true and fair view of the company accounts? Well no because it was obvious there were no cos charges included in the accounts because they had been paid by another company. I feel justified now in my argument. Thank you

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Replying to aceman2:
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By WhichTyler
15th Feb 2020 17:06

aceman2 wrote:

There were suggestions of malpractice or possible fraudulent activity. I know this not to be true


They are claiming a taxable deduction and possibly recovering VAT in the other business for goods/services that were not used in that business or that taxable activity
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By adam.arca
15th Feb 2020 10:40

IF the shareholders are the same across all companies, and IF the tax position (VAT and CT) across the "group" is unaffected, and IF I thought this was simply a case of laziness (trading relationship with suppliers in the other companies and directors too bone idle to raise I/C invoices perhaps?), then I might tend towards a relaxed view THIS ONCE. But really directors need to be told to pull their socks up for all sorts of reasons we can all think of.

If you're insisting on a COS provision, then really you need to be sure the other companies are also accruing for unbilled sales; ideally you'd want to see the I/C invoices actually raised before you sign off.

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Hallerud at Easter
By DJKL
15th Feb 2020 13:01

Common sense suggests correction, but if the pair you are working with do not respond to common sense try scaring them- if the current GP% is out of kilt you can point out that if, in a future year, it was to return to a more normal percentage (drop) then they are running an increased risk of HMRC's systems raising the question why has such a change happened.

I appreciate maybe these days HMRC do not pull on such a basis but they certainly did in years gone by.

Maybe asking them why they will not correct in all sets of accounts is the more obvious question? Subject to response dumping them as clients (if they ignore your professional judgement on such an important point they probably ought not to be your clients) and the necessary SAR reporting that arises if they will not mend their ways is where you probably want to go.

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By Manchester_man
15th Feb 2020 14:12

When the clients object to the idea of cross charging COS to the other entity(ies), what reason are they giving as the basis of their objection?

It is the objection in itself that would be causing alarm bells to ring for me. Most clients, I suspect, would take the advice given or at worst would come out with something like “I don’t quite see the need to make any adjustment but I will follow your professional advice.”

For such a pointed objection, they must surely have a reason for their position and it is this that may be key (as Lion said above “why”?).

For example, are they saying
“we don’t want to put any adjustments through just to make the figures look more realistic”
or perhaps “it’s too much hassle / there is no need “
or rather more blatant “that would draw attention to the fact that company B is reclaiming VAT on the COS of Company A so we don’t want to do that”

Or a whole raft of other possible reasons for their objection.

I’d be surprised if they have just said “we don’t want to and that’s that”; is there not a “because”?

I may have missed it, but do we yet know whether one, the other or all companies are registered for VAT?

Interesting one

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By atleastisoundknowledgable...
15th Feb 2020 16:24

Hate to play devil’s advocate, but the accounts do give ‘ a true and fair view of the company accounts’ don’t they? If they didn’t pay much/anything for the stock/materials so they have a massive GP, then that’s the case and the accounts should show that. If largecos aren’t charging them, then that’s their business.

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Replying to atleastisoundknowledgable...:
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By Wanderer
15th Feb 2020 16:40

That's not the criteria though. The requirement is that they show a true and fair view of the profit or loss of the company (& state of affairs). In the OP's case the company hasn't really made a profit of x, its profit is y but the accounts are presently showing x because costs have been omitted.

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By frankfx
15th Feb 2020 17:32

You have not provided any numbers to give us the scale of the problem.

Are large co. staff issuing purchase orders to suppliers knowing that small co gets the benefit.

The costs lost inside large co, and knowingly so, is fraud.

Are goods and services knowingly delivered to the wrong site or project.

Large co is getting a tax advantage.

Are staff in large co. Entitled to a performance bonus, and therefore reduced by this policy?
Fraud?

Is large co. In some financial difficulty.

Small co. May ultimately deprive large co stakeholders.

And so on.

Tangled web of deception .

For no good reason or credible explanation.

It seems that the fundamental expectation that the accounts show a true and fair view is being completely ignored.

You can not ignore this.
The elephant dominates the room.

If you were challenged by a solicitor, HMRC or your regulator you would be found wanting.
What you didn't spot the elephant, and nor it's excrement?

Shaving mirror moment?

You know that.

This matter is of resignation proportions.

Imagine new accountants seeking an explanation for mega GP %

Have you made an error?

And so on.

You are placed in an invidious position.

Show the directors the code of practice you are Required to follow, as other accountants are equally obliged to adhere too.

Demonstrate your total professionalism.

Let them respect you.

Thank you for sharing this snake bite of a dilemma.

Good luck..

Let us know outcome.

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By thomas34
16th Feb 2020 08:51

What an interesting question - a bit like the very old days when the forum was actually a useful CPD tool.

There's still a lot of information missing. Are we agreed that the shareholders are the directors also of all companies (the OP hints that there may be some minor shareholders in the larger companies such that those minor shareholders may be disadvantaged by artificial diminution of profits)?

The "small" company may have a T/O of £9.9M - we don't know.

I think the OP should be studying the last filed accounts of the 2 larger companies. Is there a trend of reducing profits such that they may cease trading at some point.

In the absence of a proper explanation from the directors I'd start with the worst case scenario that they were intending to phoenix the two larger companies at some point.

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By lesley.barnes
16th Feb 2020 09:43

Are you an employee of one of these companies ? I only ask because in your previous post you mention moving to employment. If so you might need to think about whether you have a future there if the shareholders ignore your advice.

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Psycho
By Wilson Philips
16th Feb 2020 10:20

The main issue, as indicated earlier, lies with the large company - if they are claiming VAT and a CT deduction in respect of expenditure that is not for the purposes of their business. Alternatively, there could be (though unlikely) transfer-pricing implications. But if company 1 is not being charged, and never likely to be charged, for the goods/services it would be inappropriate to accrue for them. The extraordinarily high GP is a reflection of the facts and the accounts would show a true and fair view of the company’s financial position. The fact that that position is different from other companies is neither here nor there.

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Replying to Wilson Philips:
Hallerud at Easter
By DJKL
16th Feb 2020 14:03

But would not show true and fair view of its performance, whilst there may be no legal obligations omitted from the debits and credits the company has used unaccounted for resources to arrive at its profits that are not reflected in the accounts- from an economic benefit approach does it not need to Debit goods received Cr Donations?

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Replying to DJKL:
Psycho
By Wilson Philips
16th Feb 2020 15:23

If a company is able to make sales, with no corresponding cost of sales, then the accounts should reflect that fact. The company is required to show a true and fair view of its own performance - there is no need to try and compare that performance with another scenario. If the company is making a 100% GP, then so be it.

If instead Company A were paying 1p for each item (so not a donation) how would you propose dealing with that?

The question is why is the company able to do this? Are the parties related? If only there was a requirement to disclose non-arm's length transactions between related parties ...

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Replying to Wilson Philips:
Hallerud at Easter
By DJKL
16th Feb 2020 15:54

What I was commenting upon was not the legal position within the accounting framework adopted and its appropriate disclosure, I was commenting on viewing accounts as a more accurate reflection of the flows of economic benefits.

Half the trouble with accounts is prescriptive rules based approaches have supplanted what accounts ought to be showing- so my comment was not what required to be shown but what ought to be required to be shown, in effect a prime example of how accounts rules have supplanted the reflection of the true consumption of resources- the approach may legally be true and fair but is miles away from what I consider true and fair.

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Replying to Wilson Philips:
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By Wanderer
16th Feb 2020 17:20

Wilson, I do understand your argument but can't help thinking that your concept is wrong.
Your argument appears to be as long as the financial statements reflect the accounting entries then the accounts give a true & fair view.
So say a company did work that it would normally charge £100,000 for but the customer is a director & it only charges 1p for it. Your argument suggests that as long as the accounts reflected the 1p sale then they would shows a true and fair view. Now whilst they may be 'true' does this really show a 'fair' reflection of the company's performance?
Your argument suggests that all auditors would have to do is ensure a set of accounts agreed to the underlying records.
Would you agree to being a party to preparation of accounts with entries showing this? I certainly wouldn't.

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Replying to Wanderer:
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By WhichTyler
16th Feb 2020 18:00

Heading off topic, but businesses might decide to work for free for all sorts of reasons that are legitimate business reasons (building market share, improving reputation in a new area, getting a foot in the door etc) but the laws are there to make sure the tax position isn't distorted or abused

so working for free for a local school has different tax/legal consequences to working for a director for free (benefit in kind) or the procurement manager of a local authority (bribery). But that doesn't mean you should adjust the accounts to industry standard margins in any of these cases.

The point is that the company doing the work for free has decided that it is in the best interest of the company to do it; it's not clear in the OP's case that this is so. Especially with respect to VAT

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Replying to Wanderer:
Psycho
By Wilson Philips
16th Feb 2020 18:17

It’s not my problem so I really couldn’t care too much. I don’t think that there is any basis for changing the figures in the accounts. If the company’s turnover is lower than it otherwise would be because it has given stuff away, so what? That doesn’t mean that the profit and loss account or balance sheet are in any way wrong.

What the accounts should of course do is disclose non-arm’s length transactions between the company and related parties/directors. It’s not my fault that the disclosure requirements in this area have been watered down.

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By lesley.barnes
16th Feb 2020 14:36

Until the poster gets to the bottom of why the shareholders want to do this and tells us I don't think we are going to come to any conclusions. The poster says they believe there is no wrong doing and that the shareholders want to show the company in a favourable light. The question why has been asked several times and not fully answered. If it's not VAT or Corp Tax(and this hasn't been answered yet) are there plans to sell off the small company? It will appear more profitable by not putting the cost of sales through. Will putting COS in reduce profit and change dividends to directors loans and create a loan charge and BIK?Something doesn't sit right with me.

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By frankfx
16th Feb 2020 14:54

Suggest Google Fraud Act.
And Companies Act 2006.

Misrepresentation .
Document on public record, knowingly deceptive.
Motives irrelevant.
There is no get out .
Directors have failed to meet fiduciary duties.
And have proffered third rate explanations that a professional will accept by looking the other way,really?

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Replying to frankfx:
Psycho
By Wilson Philips
16th Feb 2020 15:29

Nonsense - unless you're talking about Company B?

What has been misrepresented? If the goods have cost nothing, they've cost nothing.
Where is the deception?
Explain how the directors have failed in their fiduciary duty to the shareholders and/or creditors. As a shareholder, I would be delighted if a company were able to increase its profits by having someone else meet its costs, thus increasing my dividends.

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By frankfx
16th Feb 2020 17:19

Super profits made in one company , mirrored by excessive costs booked in second company.
Small co. is presenting accounts distorted by directors.

Perhaps Steve Collings could , openly , place his opinion on this forum.

Worth a look ?
FRS 102 disclosure Big co. may/should have a related party note regarding transactions:
'' not undertaken at normal market conditions ''

I can not imagine an AWEB accountant suggesting to directors a 'scheme' to improve look and feel of small co . balance sheet, along the lines outlined.

This 'free lunch' is putrid and indigestible.

Home work assessment for student :

What written representations and assurances would an AWEB accountant seek from the directors , in the context of false accounting, and place on the accounts preparation file ?

see section 2 below

False accounting.
(1)Where a person dishonestly, with a view to gain for himself or another or with intent to cause loss to another,—
(a)destroys, defaces, conceals or falsifies any account or any record or document made or required for any accounting purpose; or
(b)in furnishing information for any purpose produces or makes use of any account, or any such record or document as aforesaid, which to his knowledge is or may be misleading, false or deceptive in a material particular;he shall, on conviction on indictment, be liable to imprisonment for a term not exceeding seven years.
(2)For purposes of this section a ( AN AWEB ACCOUNTANT ) person who makes or ( AWEB accountant concurs ) concurs in making in an account or other document an entry which is or may be misleading, false or deceptive in a material particular, or who omits or concurs in omitting a material particular from an account or other document, is to be treated as falsifying the account or document.

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