Small Companies (Micro-Entities’ Accounts) Regulations 2013

Earl of Erroll Excerpts

Tuesday 26th November 2013 Grand Committee

[The Parliamentary Under-Secretary of State, Department for Business, Innovation and Skills (Viscount Younger of Leckie) (Con)]

My Lords, the purpose of these regulations is to implement legislative flexibilities introduced by the EU’s micros directive, which are now incorporated in the new accounting directive. This directive sets an important precedent in European company law. It recognises the need to reduce burdens on our smallest companies to a more proportionate level and creates a new category of company, the micro-entity. A micro-entity company is one which, at the end of the period to which its balance sheet relates, does not exceed two of the following conditions: having a balance sheet total—that is, a gross assets total—of £315,000; having an annual turnover of £632,000; and having an average number of 10 employees during the financial year.

There are an estimated 1.56 million micro-entities in the UK. Many are engaged in business at a local or regional level. They are significant contributors to the UK economy, creating employment and developing new economic activities, but they are burdened by detailed accounting requirements, from requiring a detailed breakdown of figures in the profit and loss account to notes on provisions for liabilities and generally uninformative information on share capital. In The Plan for Growth, published in March 2011, the Government set out their ambition,

“to make the UK one of the best places in Europe to start, finance and grow a business”.

They identified that this could be achieved, in part, by lessening the regulatory burden on business.

At present, our smallest companies must comply with the same financial reporting rules as other small companies, which may be 20 times bigger. The Government do not believe that this is necessary for most micro-entities. We should remember that our current financial reporting requirements are meant to address the information needs that exist between the shareholders and the management of the company, where there is a separation between its ownership and management. For micro-entities, there is often no such separation of control. That is because many micro-entities are owner-managed. Indeed, research has indicated that approximately 45% of these companies have only one shareholder, and that often the owner is the only employee. Therefore, the statutory financial statements are not necessary for the communication of the company’s performance. The burdens associated with comprehensive financial reporting requirements may be disproportionate and yet offer no real benefit. Why should they produce pages of financial data when they are not going to make use of them and no one else is really interested?

The directive provided a number of options for member states to consider but it explicitly recognised that member states would need to assess how these options complemented their financial reporting regimes. I will put this in perspective. France and Germany have already adopted lighter-touch reporting regimes for their smallest companies and others, such as Denmark and Poland, are considering doing so. The flexibility offered to micro-entities will be known as the micros exemption.

The Government sought views on the implementation on the various parts of the exemption and, as the directive allows, the regulations will, first, enable micro-entities to prepare and publish simple, highly abridged financial statements and, secondly, relieve micro-entities of the obligation to produce the full notes to the accounts, provided that specified notes are placed at the foot of the balance sheet. These are limited to information around commitments by way of guarantees, and any advances and credits to the directors.

The consultation identified two issues, however, which prompted significant concerns. The first was the application of the true and fair principle in relation to micro-entity accounts. Several respondents noted that the micros exemption would allow directors to state that the micro-entity accounts gave a true and fair view of the company’s financial position, provided the accounts complied with the directive. Respondents questioned how this could be achieved, given the much-reduced nature of those accounts. They argued that this would conflict with the UK approach, where company accounts are considered to provide a true and fair view only if they are prepared in accordance with accounting standards that require higher levels of disclosure.

The second issue related to the ability to provide exemption from certain aspects of accruals accounting. Nearly all the respondents opposed the introduction of this provision, noting that such an approach would lead to confusion for micro-entities, add unnecessary complexity to the preparation of the company’s financial statements, and produce little, if anything, by way of savings.

Respondents argued that the result in both instances would lead to reduced confidence in the financial statements themselves, and could even present a misleading position of the financial health of the company. The Government held discussions with professional bodies to consider the issues in more detail.

First, on the issue of true and fair, we acknowledge the potential for conflicts with other areas of regulation. Accordingly, the regulations make clear that only those aspects of accounting standards which conflict with the reduced reporting requirements of micro-accounts may be set aside. They also make clear that should micro-entities voluntarily provide additional information, this information must comply fully with the relevant accounting standard in order to be true and fair. For example, if you decide to include a fixed assets note, the information you provide must comply with accounting standards.

Secondly, on the issue of partial accruals accounting, we recognise the concerns raised and agree that confidence in financial statements must not be undermined. To ensure consistency, we will not implement this option in the UK.

I should point out that there are some exclusions for which reduced levels of information would clearly be inappropriate. Therefore, certain types of financial and investment bodies-for example, credit unions or hedge funds-and any company currently excluded from the small company regime, may not take advantage of the exemption for micros. Charitable companies are also excluded. This follows discussion with the Charity Commissioners, who wished such companies to remain subject to the additional accounting rules applied to them, thereby retaining the higher level of transparency expected by those who donate to important causes through charitable companies.

Exclusions aside, the Government recognise that micro-accounts will not be suitable for all micro-entities; but we believe it is appropriate to provide companies with a choice. The decision to prepare and publish micro-entity accounts will be a business decision for a company’s directors: one based on the current and future information needs of the company. But simple businesses will now have the option of preparing truly simple accounts. I commend this regulation to the Committee.

[The Earl of Erroll (CB)]

My Lords, I will ask a quick question. This issue occurred in relation to something else where there were exemptions for small companies, SMEs or micro-companies. It is in the definition of companies that qualify as micro-entities. The third criterion that can be applied is the number of employees: not more than 10. It then talks about averaging the number of people in contracts of service. If you employ two people part-time—for instance, one who has young children and wants to take them to and pick them up from school, and the other who is retired, say, and happy to fill in for the rest of the day—you are employing two people, but you only have one full-time equivalent. In that kind of situation, or with people working seasonally or casually, this criterion could discriminate against small employers who are trying to get several people all doing a bit of part-time work for them, because the number of employees could then easily exceed 10. Therefore, it should probably be worded as full-time equivalents in future. I will not suggest anything here, but I want to flag up the general point to regulation-makers that it would be fairer on small entities if there was some way to bring it back to full-time equivalents.

[Baroness Donaghy (Lab)]

First, I welcome anything that makes life easier for small businesses. I have often felt that the definition of small and medium-sized enterprises that fits in with the European definition is somewhat misleading in our country because a medium enterprise as per the definition would be regarded as quite a large company in the UK, so to recognise micros in this way is more than welcome.

I have a question for the Minister that I suppose relates to the flexibility of the definitions of turnover, balance and staffing, referred to by the previous speaker. I hastily looked through both the impact assessment and the regulations and could not find anywhere how the updating of the turnovers and balances will take place. What length of time is considered reasonable? I believe that the issue of part-time equivalents is quite important, particularly for companies of this kind that might start off in a fairly informal way. It is actually written in to the regulations, which I presume means it is quite inflexible.

--- Later in debate ---

[Viscount Younger of Leckie]

My Lords, I thank members of the Committee for their valuable and detailed comments during this debate and for their general support for this provision. I thank my noble friend Lord Cope of Berkeley for reiterating that this is a European measure that will benefit small companies. It introduces into EU law a definition of a micro-entity, as I said in my speech.

I remind noble Lords that the directive sets an important precedent in setting down a legal definition for a micro-entity and enables member states to take up flexibilities suited to their national needs, and to reduce the administrative burdens on these very small companies. This regulation is deregulatory and will enable the smallest and simplest companies to prepare simpler accounts that are proportionate to their size and that reflect their needs. It is entirely voluntary. The ability of micro-entities to produce simple accounts will lift unnecessary burdens, enabling micro-entities to focus on running and growing their businesses.

A number of questions were asked by noble Lords. I shall first address the question asked by the noble Baroness, Lady Hayter, about the consultation. She stated that she thought that it lasted only three weeks. The consultation was, in fact, a continuation of a long period of informal discussion and built on an earlier discussion paper of which she may be aware. We worked closely with the FRC throughout, and it has been extremely supportive.

The noble Earl, Lord Erroll, asked an interesting question about the definition of “employee” and made the point that employees can be defined in a number of ways, depending on whether they are defined as part-time. The quick answer is that for this purpose the count is defined as the number of employees, not how many hours they work. This wording is set out in the directive. I am not sure whether that completely clarifies the question, but that is how the count is defined.

[The Earl of Erroll]

That completely but disappointingly clarifies the point, because it does not recognise that if you have someone coming in for two hours a week, which HMRC might regard as full-time since it is regular employment, it will count against you as a micro, which is sad. It may be that this could be raised at a European level.

[Viscount Younger of Leckie]

I suspected that that answer might disappoint the noble Earl. I will be delighted to recheck with officials on that specific question and write to him to clarify.

The noble Baroness, Lady Hayter, later asked about charities and what they feel about the exclusion of charitable companies. There were no responses to the public consultation from individual charities, but we worked closely with the Charity Commission throughout, as I said in my speech, and we continue to work with it to consider how burdens can be removed for this group. We will consult again. I hope the noble Baroness will be pleased when I say that that will be done as soon as 2014.

The noble Baroness, Lady Donaghy, asked how the updating of balances will take place and about the definitions of the criteria on how turnover, for example, will be met. The regulations are subject to review by the Commission on a regular basis. I have just checked what precisely that means, and it means on a five-yearly basis. As the directive updates the thresholds, the Government will reflect them in UK legislation to allow the greatest possible number to take advantage of the exemption.

The noble Baroness, Lady Hayter, asked about the Charity Finance Group, which has asked the FRC to consider the needs of small charities. This is another charities-focused question. The FRC will work with the commissioners and BIS to address their concerns. A new SORP—statement of recommended practice—for the preparation of accounts is being prepared to update the guidance.

The noble Baroness, Lady Hayter, also raised the issue of small trade unions and why other measures increasing the accounting regulations on them are being introduced. In fact, she alluded to Part 3 of the Transparency of Lobbying etc. Bill which, as she said, I take the lead on. I do not want to be drawn into that on this particular issue but it is important that we consider each policy carefully and on its own merits. The Government are working to reduce the burdens across a range of areas and will do so wherever possible. Micro-entity regulations, on which we are focused today, are an example of that.

Finally, I draw the attention of noble Lords to the important element of choice for businesses. Micro-entities will be able to choose whether to adopt micro-entity, small company or full accounts. The Government conclude that the regulation meets the requirements of the Act and I commend this regulation to the Committee.