Last week, the government set out plans to simplify and modernise corporate reporting, with changes proposed across audit, financial reporting standards, dividends and non-financial reporting. There are potential positives for businesses (and therefore the UK economy) but there are also areas which have left me pondering whether many of the proposals are the right answer for all stakeholders.
The consultation is open for 12 weeks and the government is looking for responses from all stakeholders. Mercia Group will be responding - if you would like your/your firm’s views incorporated into our response, please reach out!
Background
The consultation argues that annual reports have grown excessively long and complicated due to years of incremental regulatory additions. Requirements are spread across company law, financial reporting standards and regulatory rules, creating duplication, confusion and unnecessary cost.
Key concerns include:
- reports serve too many audiences and policy objectives, obscuring the purpose of annual reports and reducing their effectiveness;
- excessive disclosure leading to boilerplate reporting and the obscuring of important information;
- requirements being scattered across company law, financial reporting standards and regulatory rules, creating overlap and inconsistency;
- multiple overlapping company size thresholds and exemptions; and
- rules have not kept pace with digital reporting.
Key proposals
The government wishes to consider how reporting obligations are determined by company size and structure. Currently, the Companies Act 2006 sets out different categories of company and a long list of exemptions and exclusions, and so the proposals include simplifying those categories and rationalising exemptions and thresholds. It’s worth noting, however, that this is not simply a proposal to remove requirements and the possibility of requirements being changed or new requirements altogether being added should not be ruled out.
Initial thoughts:
The underlying concept of this is great - there are too many complex rules, which make life difficult for companies (and their accountants and auditors). However, there are areas which will be challenging to implement or to even consider.
What’s good (mostly):
- Clearer statement of purpose - the concept of having overarching principles with help with clarity:
- Clarity of purpose
- Flexibility and trust
- Simplicity and coherence
- Proportionality
- Fit for the future
- Removing duplication by bringing company law requirements into financial reporting standards to ensure requirements sit in one place
- Rationalising financial reporting standards - four clear tiers (IAS, UK GAAP for large/SMEs/micros) - and ensuring that there are not what feels like a million and one different variations of the largest size category for narrative disclosure purposes!
- Reducing the burden for the majority of SMEs (including for narrative reporting) - this will essentially align medium and small companies to create a simpler regime. It includes scrapping off Strategic Report (NB Director’s Report being scrapped through ECCTA) and no cashflow statements and preparation of consolidated accounts
- Digital first reporting - to bring reporting into the modern age, the consultation contains several digital modernisation proposals which (mostly) appear sensible (e.g. including clarifying that virtual AGMs can be held where shareholders consent)
- Administrative changes - including requiring companies to notify Companies House when they appoint an auditor, remove the statement of circumstances requirement relating to non-PIEs and the requirement to send any of them to the FRC
- The concept of a ‘Reporting Gateway’ - a new checkpoint to screen future reporting requirements for cost-benefit, international alignment and usability
What needs more consideration:
Timing
One of my biggest concerns is the practicalities of implementing what is agreed. Given the size and breadth of this consultation, it is not going to be a short period of time for implementation. It is likely that this will be undertaken over a period of years. Linked to this, I really question whether 12 weeks is long enough for this type of consultation! I fear I need to read the consultation quite a few more times to truly understand the detail (it’s 70 pages with 60 questions!).
I suspect (or hope at least) that we will need further consultations surrounding the detail to ensure that the UK is leading the way in these developments.
Who the accounts are for
Under the overarching principle on ‘clarity of purpose’, the consultation suggests that the annual accounts are for current and future investors and creditors. This means there is less of a focus on other stakeholders such as employees and customers. It will be interesting to hear from companies, and accounting firms feel this is the right answer.
Financial reporting standards
For those UK GAAP financial reporting categories, there is a proposal for a separate standard for ‘not-for-profits’. It appears that this would effectively make the statement of recommended practices (SORPs) redundant. This feels way too basic for the maturity of the UK market and appears to have a lack of detailed consideration. The consultation notes that it would reduce the reliance on SORPs, alleviate some specific accounting and financial reporting issues faced by not-for-profits and reduce the complexity faced by this sector. It is unlikely that preparers of financial statements would be keen on the loss of any of the detailed SORPs.
There is a question over whether there should also be a ‘very large’ classification as well. I fear there is some broad pigeon holing that ‘very big’ equals ‘of public interest’, but I’m not sure that is always the case.
All under one roof (removing duplication)
I noted this as an advantage, but I am unclear as to how it could work in all circumstances. For example, wouldn’t UK-IAS still need law to ‘bolt on’ what is not covered by IFRS standards where there are some requirements which currently sit within law (e.g. off-balance sheet arrangements, auditors’ remuneration)?
Saying goodbye to the concept of true and fair for SMEs
Currently the concept of true and fair is the overriding principle governing the presentation of financial statements, regardless of whether companies produce UK-IAS accounts or Companies Act 2006 accounts. It notes that the true and fair concept, while applicable to all companies, applies differently according to the type of company and type of accounting, and there is no statutory definition. I welcome the idea to align legislation across both UK-IAS accounts and Companies Act 2006 accounts so that a single true and fair requirement is applied to all companies that are within scope. I also agree with the proposal for micro-entities to comply with the financial reporting standard for micro-entities (rather than the current presumed true and fair view). Where I struggle is on the proposal to prepare accounts in accordance with the SME financial reporting standards only. The consultation recognises that this would be a significant departure from the current situation. It states that their assumption is that compliance with financial reporting standards is sufficient to meet the information needs of investors and creditors. This feels very counter intuitive to feedback from monitoring bodies, which emphasises the need for balanced reporting (albeit that is largely driven by the need for T&F disclosures!), so perhaps such a change would drive a different attitude from monitoring bodies.
There is a knock-on issue here as it would not be appropriate to require auditors to give an opinion on whether accounts show a true and fair view if we remove this requirement from directors themselves. Under these circumstances, an audit could consider compliance with the financial reporting standard, but it is important to recognise the interdependency between these two policy proposals.
Watering down of audit
I am undecided as to whether I agree that medium-sized companies should be audit exempt. With recent revisions to size thresholds, this would take a large number of companies out of the audit regime (especially once coupled with potential changes to subsidiary audit rules as well - perhaps one for another article!). Whilst I can clearly see the benefit of entities not having to pay for an audit, we do need to balance this with the many advantages that audit brings to businesses and our economy. As an audit geek, it feels like it is cheapening the audit profession as to why businesses and the wider economy ultimately benefit from the audit process. There is also the very real consideration of whether potential investors will invest without audited accounts. It will be interesting to hear HMRC’s views on whether audit exempting this number of companies is a good concept.
The consultation introduces the concept of a separate assurance standard. For me, this seems poorly considered. The ICAEW tried to engage the profession over a decade ago with a limited assurance engagement (see TECHNICAL RELEASE 09/13AAF (REVISED)), which didn’t really go anywhere and I question whether the FRC would get on board given it hasn’t shown much interest in the ISA for LCEs, with one criticism being the creation of a two-tier audit system (although perhaps, this would be a preference for it!).
The impact on audit firms and the profession would be significant and does not appear to have been considered. This will potentially leave only auditors of PIEs remaining, and we will lose a huge number of skills within the profession. This will make it even more challenging for the profession to bring in new talent (especially with the ever-growing usage of AI). Of course, those businesses which appreciate the value of audits will still be able to request a voluntary audit. We see this frequently already in the profession.
Thoughts are very much welcome!
Distributable profits
The consultation proposes to replace the distributable profits rules with a solvency-based regime to determine the legality of dividends. Whilst this simplification was originally on my list of what’s good - the more I think about this, the more concerned I become. The current rules are complex, but they are complex for a very good reason. It is positive that the consultation suggests companies would need to state that the payment of the dividend will not affect their ability to continue as a going concern.
However, given weaknesses in going concern reporting and conclusions, I fear the flood gates could open on issues here. I think there would need to be a clear strengthening of repercussions for ‘illegal dividends’ such that the directors declaring and shareholders receiving were very clearly on the hook for repayment in the situation where the company goes bust.
Sustainability reporting
The issue is that there are already reforms ongoing and so trying to knit this together comes across as problematic, with S1 and S2 only being released for ‘voluntary use’ and the FCA consulting on making these mandatory for those using the listing rules. There is also the separate climate-related financial disclosure regulations post-implementation review which is expected to conclude in spring 2027 which is not touched by this consultation. The real risk here is pulling these all together with the concept of this consultation which is whether it seeks to consider whether private companies should have to report under SRSs. How will the sequence of these events pull together?
Linking this reporting to assurance is also problematic. Questions such as ‘where does the reporting sit in the annual accounts?’ arise. This can impact what work auditors/assurance providers perform.
Conclusion
This consultation is certainly going to be a discussion point for companies, their investors, other stakeholders and the accounting and audit profession over the coming months. Please feel free to speak to me or one of the A&A team to voice your views! I am not welded to all my meandering thoughts noted above but love a big debate!