ANNUAL ACCOUNTS for the smallest businesses could be simplified after the Financial Reporting Council (FRC) and the Department for Business, Innovation and Skills (BIS) issued a joint missive on cutting red tape for micro-entities.
Timed to coincide with an Office of Tax Simplification (OTS) consultation on SMEs, the FRC has proposed the paper as a first step to freeing these businesses from the shackles of accounting drudgery.
It follows a European Union vote that paved the way for reduced reporting requirements in member states, but UK stakeholders are divided on the issue.
Chief among the objections is the worry that simpler reports will make creditors reluctant to lend and traders indisposed to engage, due to fears that mini-companies will be unable to honour debts.
However, supporters argue that cutting red tape will free time and resources, allowing businesses to thrive and revving the economy from the bottom up.
Micro-entities are defined as companies with a turnover of less than £440,000, net assets under £220,000 and fewer than 10 employees. Their accounts users include banks, investors, credit rating agencies, trading partners and HM Revenue & Customs, all of whom must be consulted.
Institutes are cautious, welcoming the principle of simpler reporting but fearing the practice. John Davies, head of technical at the Association of Chartered Certified Accountants (ACCA), said that “preparing accounts is important from the perspective of financial discipline”, but added that the institute is “open” to evidence of exigent reporting requirements ripe for the chop.
The Institute of Chartered Accountants in England and Wales agreed. “Sound financial management continues to be the bedrock of any business,” it said. “Whether the proposed requirement is the right one needs to be debated carefully.”
Credit rating agencies are even less enamoured. The Institute of Credit Management (ICM) questioned 8,000 members, and found almost 37% would insist on a cash advance before supplying a company without ready and detailed financial data.
Only 15% would trade if accounts were not available through Companies House or a credit rating agency, while almost half (48%) would request more information.
Economic growth could be stifled if the reporting regime slackens, according to ICM chief executive Philip King. “Without audited numbers that can be trusted, banks will not lend and suppliers will not extend credit to their customers,” he said. “Credit fuels business and access to credit comes from greater access to information, not less.”
Interestingly, some seem untroubled by the prospect. Brian Capon of the British Bankers’ Association (BBA) said the decision to lend is based on other information with “little emphasis on audited accounts” when it comes to smaller businesses.
“To a large extent, accounts are historic. They can provide comfort, but won’t affect adversely lenders’ decisions,” he observed. Instead, banks focus on business plans and future cashflows.
The BIS/FRC proposition calls for a simplified trading statement, a statement of position and a simplified annual return.
Of particular concern to some doubters is the lack of a true and fair view. It does away with accruals accounting in favour of simpler cash accounting, meaning companies would only recognise funds paid or received and be under no obligation to set out future liabilities.
This could reduce the value of such accounts, as the reader would have no idea about material liabilities affecting the company. It would also result in a stark difference between micro-entity reporting and larger businesses’ accounts, where a true and fair view will remain the norm.
Indeed, the proposition takes EU musings on cutting red tape to new extremes. On this basis, it would seem BIS and the FRC are testing the water rather than expressing a serious intention.
The Office of Tax Simplification is also dabbling in SME-boosting measures, and recently announced it is considering removing GAAP, or using non-profit measures as the basis of taxation.
A document produced in July said new ways to help businesses deal with their tax obligations are needed. The FRC/BIS discussion paper may have been churned out as an afterthought, with policymakers hoping easy accounts and easy tax will be the one-stop-shop for SME growth.
The FRC does make one concession to those who say credit lines are greased by robust accounting. The simpler requirements would not preclude reporting at a higher standard “if [this] was thought to be a more appropriate way of meeting particular business requirements”.
About half of small businesses choose to file full accounts, indicating a willingness to continue with more stringent standards if this is deemed attractive to lenders.
However, the BBA’s Brian Capon said the requirement for strong financial reporting is “likely to be on a case-by-case basis”, meaning companies may not know in advance when full accounts are needed.
Further consultation is clearly needed before BIS can cut the red tape – and the issue is still under discussion in the EU.
If different users do have different needs, those preparing micro-entity accounts will have to be alert and not simply slash reporting to an easy minimum. The FRC will need to educate on this, and it may also wish to remind SMEs of the commercial value of financial reporting.
The UK’s imminent exit from the EU that may now put the audit committee to the ultimate test
Audit tendering has turned from good practice to legal practice under the EU audit reforms
Businesses will have to think more strategically about where they can source those non-audit services in the future
The FRC has raised concerns that the FTSE 350 audit market remains highly concentrated among the Big Four despite high levels of tendering and rotation