The dust is now starting to settle on new UK GAAP for small companies in the form of FRS 102 section 1A and practitioners are starting to get into the detail of the disclosures and how they impact on shareholder and filed accounts.
One area that is creating much discussion concerns the disclosure of directors’ salaries and dividends in small owner-managed companies. Here are some of the most common questions:
How small is small?
The thresholds used to determine whether or not a company is small are laid out in the updated Companies Act: turnover: ≤ £10.2M; gross assets: ≤ £5.1M; employee numbers: ≤ 50. Where a company breaches two out of the three thresholds it is a medium-sized company.
Doesn’t company law specifically require disclosure of directors’ pay?
It used to. However, Companies Act revisions driven by the new EU Accounting Directive mean it no longer does. Therefore, directors’ salaries and dividends are now covered by the more general requirement to disclose related party transactions.
So directors’ pay is bound to require disclosure anyhow?
Not necessarily, since the disclosures in this area are somewhat ‘dumbed down’ by the Companies Act revisions as well. Although transactions with directors do qualify as related party transactions they only need to be disclosed where they have ‘not been concluded under normal market conditions.’
How do I reach a conclusion on that?
One way might be to benchmark what a director is getting paid against what it would cost to recruit someone externally to do their job. Since owner-managers tend to minimise salary and maximise dividend in order to be tax efficient, this approach might well lead one to conclude that the remuneration is not a transaction ‘concluded under normal market conditions’. This would then trigger a disclosure in the statutory accounts.
Another way of looking at it is that, in UK owner-managed companies, minimising salary and maximising dividend is the norm and that this type of remuneration arrangement IS therefore a transaction concluded under normal market conditions. On that basis, the remuneration would not need to be disclosed in the statutory accounts.
Owner-managers and their professional advisors definitely do and this is as a result of the new filing regime for small companies also ushered in by the recent Companies Act revisions.
Abbreviated accounts have now been abolished and small companies must (per s444 of the Companies Act 2006) file their shareholder accounts – although they are allowed to ‘fillet out’ the profit and loss account and any profit and loss account related notes for filing purposes.
Since the related party transactions note is not a profit and loss account related note, it would need to be filed by a small company. So, if the directors of a small company conclude that a low salary/high dividend combination is the norm, then non-disclosure would avoid details of these transactions being placed on the public record.
Surely shareholder accounts won’t be ‘true and fair’ if remuneration details are excluded?
This could be argued. In fact, the Financial Reporting Council (FRC) actively encourages ‘over disclosure’ by small companies to ensure that a true and fair view prevails. However, as mentioned above, disclosure of such transactions in the shareholder accounts will mean more public record disclosure than under the previous abbreviated accounts regime.
‘Over disclosure’ should definitely be considered where a small company has external shareholders not involved in the business day to day. Might non-disclosure of directors’ salaries and dividends conceal otherwise important information from them?
Won’t banks need this information anyway?
Disclosure of directors’ salaries and dividends definitely helps a bank understand the dynamics of a small company and its information needs are definitely worth considering.
However, many feel that the financial statements are prepared for the benefit of the shareholders and that a bank can fight its own battles when seeking out additional information.
Isn’t there a more general need to disclose dividends paid by small companies?
Appendix D of Section 1A of FRS 102 strongly recommends that small companies disclose dividends paid in aggregate in their shareholder accounts. Technically a company could look to spurn this requirement based on the fact it’s not legally required.
If it does disclose the dividends paid figure though, there could again be a knock-on disclosure implication in the filed accounts because of section 444. So if a dividends note is used to quantify the dividend, this note would not get ‘filleted out’ for filing purposes as a dividends note is not a P&L note.
FRS 102 does state more generally that where the only things that cause equity (capital and reserves) to change year on year are profit, dividends and prior-year adjustments, a ‘statement of income and retained earnings (SOIRE)’ can be produced as a primary performance statement. This is effectively a P&L-substitute with the dividends paid figure presented at the bottom.
If a company were eligible to and chose to present aggregate dividends paid this way, the SOIRE would get filleted out for filing and the aggregate dividends paid figure would not get disclosed on the public record.
A recent ICAEW helpsheet on the filing requirements under the new small company regime has also suggested that if a small company uses a statement of changes in equity to explain transactions with shareholders (including aggregate dividends), this can also be ‘filleted out’ for filing purposes.
What if a small company qualifies as a micro-entity?
The micro-entity regime in FRS 105 requires minimal disclosure. Related party transactions (including dividends and remuneration paid to owner-managers) don’t require disclosure. Nor do aggregate dividends, even though micro entity accounts are ‘deemed true and fair’.
The thresholds used to determine whether or not a company is micro are laid out in the updated Companies Act: turnover: ≤ £632k; gross assets: ≤ £316k employee numbers: ≤ 10.
What impact is Brexit likely to have on this debate?
There definitely seems to be ‘tension’ in FRS 102 Section 1A between what the new Companies Act requires (less disclosure for small companies) and what the Financial Reporting Council desires (sufficient transparency to ensure that a true and fair view prevails in the shareholder accounts).
Given that the Companies Act revisions are based on the new EU Accounting Directive, the UK could turn its back on them in due course. However, with everything else that Article 50 will entail, don’t expect major changes anytime soon!