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by John Davies 01 Jul 2000 Diploma in Financial Management Relevant to All Papers

Review of UK Company Law

The first of these initiatives is the Government-sponsored review of UK company law. This is a major exercise, the first review of its kind in 40 years. It is re-examining the whole of company law, from issues of basic principle such as the scope of directors’ duties to points of detail such as the permitted deadline for applying to restore a defunct company to the register.

Two key objectives have been identified by the review team to guide the work of the review. The first of these is to ensure the quality of company decision-making by requiring directors to take into account a range of factors thought to be conducive to this end. It is proposed that the range of factors to be taken into account should include good internal governance, the long-term as well as the short-term consequences of decision-making, and the interests of employees, suppliers, the environment and communities affected by the company’s actions: what is often termed the ‘stakeholder agenda’. Secondly, the team proposes to ensure that companies are accountable to their shareholders and other stakeholders to a level which is appropriate in the light of the circumstances of the company concerned. This second objective has led the review team to examine what the reporting process should be expected to achieve, and to consider what changes might be desirable in order to make financial reporting meaningful to users.

The review team has acknowledged that the basic rules on the form and content of the profit and loss account and the balance sheet are set by European law. In view of this, no unilateral changes to the rules governing these statements can be contemplated (although some, arguably cosmetic changes to the rules on the profit and loss account are suggested).

The team is, however, proposing a clear separation of the rules governing reporting by ‘small’ companies and others. There will, if the team’s proposals are accepted, be a rigorous new regime for companies listed on the Stock Market and a light touch regime for small companies. Companies which are ‘large’ in financial terms but not listed are likely to have to comply with a modified version of the listed company regime.

Under the proposals, listed companies would have to prepare a statutory version of the preliminary statement that they currently have to prepare for Stock Exchange purposes. This would have to be prepared and filed with the Registrar within 70 days of the year end. Controversially, the team is suggesting that this report, rather than the full accounts or a summary thereof, be distributed automatically to shareholders.

The company’s full accounts would then have to be prepared and filed within 90 days of the year end, a substantial reduction in the current 7-month period allowed for filing. These full accounts would need to include, as well as the two primary statements, a new, statutory version of the Operating and Financial Review (OFR), a statement which is, at present, not mandatory but the subject of guidance as to form and content issued by the Accounting Standards Board (ASB). Most listed companies have, in the event, chosen to prepare an OFR along the lines suggested by the ASB.

The review team envisages that the OFR as it is currently framed can be expanded so as to constitute the main means by which companies explain to their stakeholders how they have performed in the light of the new requirements for companies to take account of stakeholder interests. It is therefore proposed that the statutory OFR requires companies to report on their policies and performance on, for example, social, ethical and environmental matters.

As far as small companies are concerned — for the purposes of the review, the team assumes that the Government will raise the turnover threshold in the Companies Act which defines ‘small’ to the maximum allowed under the Fourth Directive, currently c£4.8 million — it is proposed that they be subject to a single, light-touch disclosure regime. There will still be a profit and loss account, balance sheet and notes and a directors’ report but the level of disclosure will be substantially less than that which applies to larger companies. Since small companies may currently prepare accounts on three different bases, rationalisation will be welcomed by most. More contentious is the review team’s plan (supported by the Government) to exempt all ‘small’ companies from the statutory audit. This would entail exempting the vast majority of all the UK’s companies from the discipline of the independent audit: lenders of finance and the Inland Revenue are known to be concerned about the potential consequences of this.

Second Initiative

Parallel to the company law review is the work being undertaken by the ASB on the shape of listed company financial reporting. ASB’s work is prompted mainly by a concern that, as disclosure rules through accounting standards and Stock Exchange requirements have increased, the length and complexity of published financial statements have made them less accessible to ordinary shareholders. There is, currently, an option for listed companies to offer their members the opportunity to be given a summary financial statement rather than the full accounts, but comparatively few companies actually offer it.

The centre-piece of ASB’s proposals is, therefore, that listed companies should be required by law to offer a summary financial statement to their shareholders. Even this, it is suggested, may not be sufficient to make company reports fully accessible and ASB goes further and proposes that companies offer their members an even simpler narrative report. Members could opt to receive automatically the full accounts, the summary statement or the basic ‘simple review’.

What both the company law review team and the ASB have in common is a concern that the present rules on financial reporting are not succeeding in providing company stakeholders with all the information they wish to have at the level they can understand it. It is likely, therefore, that significant changes in reporting rules are on the horizon. Any change to the legal rules, at least, will, however, not be introduced for at least two years. Diploma students will be kept informed of what specific changes they need to be aware of in due course.

 

The basic framework of company financial reporting in the UK has remained constant for nearly two decades. In 1980, the Government implemented the Fourth EC Company Law Directive, thereby laying down the rules on the form and content of statutory company accounts which we still have today. These rules, now found in the Companies Act 1985, require companies to produce, as primary financial statements, a profit and loss account and a balance sheet, supplemented by additional information disclosed as notes to those statements. The Act sets out the headings and sub-headings under which financial information is to be disclosed in the main financial statements. In addition, narrative information about the company’s financial position (and other matters) is required to be disclosed in the statutory directors’ report to shareholders. The overriding rule governing the presentation of information in the accounts is that they (the accounts) must give a ‘true and fair view’ of the company’s profit or loss and financial position at the balance sheet date. If strict compliance with the statutory rules on presentation would conflict with this requirement, then departure from those rules is permitted. At the same time, companies are required to disclose information over and above the minimum required by the rules if this would be necessary for the accounts to give a ‘true and fair view’. When approved by a company’s directors, the accounts must be audited by a qualified auditor and then filed with the Registrar of Companies within the deadlines allowed by law, which are seven months in the case of a public limited company and ten months in the case of a private company. While piecemeal changes have been made to this statutory framework since 1980, and the accounting standards authorities have, during this period, issued much detailed guidance on the measurement of accounting information, the framework has remained fundamentally intact. Two current initiatives are, however, likely to lead to important changes to this situation.

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