Simpler SME reporting ties users in knots

ANNUAL ACCOUNTS for the smallest businesses could be simplified following a joint Financial Reporting Council and Department for Business, Innovation and Skills (BIS) 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 them 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 their objections is the worry that simpler financial reports will make creditors reluctant to lend and traders reluctant to engage, fearing the mini-companies will be unable to honour their debts.

On the other side, supporters argue that cutting a swathe through red tape will liberate 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 ten employees. Their account users include banks, investors, credit rating agencies, trading partners and the tax man, all of whom must be consulted.

Institutes are cautious, welcoming the principle of simpler reporting but fearing the practice. John Davies, ACCA head of technical, said: “Preparing accounts is important from the perspective of financial discipline,” but conceded that the institute would be “open” to evidence of exigent reporting requirements ripe for the chop.

The ICAEW agreed. “Sound financial management continues to be the bedrock of any business, regardless of its size,” it said, concluding: “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 interrogated 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 even if accounts were not available through Companies House or a credit rating agency, while almost half (48%) would request additional 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 … credit fuels business – access to credit comes from greater access to information, not less.”

Interestingly, some of those whom he is fighting for seem untroubled by the prospect. Brian Capon of the British Bankers’ Association said when it comes to smaller businesses, the decision to lend is based upon other information with “little emphasis on audited accounts”.

“To a large extent, accounts are historic – they can provide extra comfort, but won’t impact adversely on lenders’ decisions,” he observed.

Instead, banks focus on business plans and future cash flows; “only on the odd occasion will they ask for more robust accounts”, Capon concluded.

The BIS/FRC proposition calls for a simplified trading statement (rather than the current profit and loss account), a statement of position – including details of assets and liabilities – and a simplified annual return.

Of particular concern to some doubters is the lack of a true and fair view in this system. It does away with accruals accounting in favour of simpler cash accounting, meaning companies would only recognise funds paid or received, and would be under no obligation to set out future liabilities.

This could dramatically 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 certainly remain the norm.

Indeed, the proposition takes EU musings on cutting red tape to new extremes, as Europe has not yet wandered down the path of cash accounting for micro-entities. 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 understand and deal with their tax obligations are needed. The FRC/BIS discussion paper might have been churned out as an afterthought to tie up this package, 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”.

Currently, around half of small businesses choose to file full accounts, potentially indicating a willingness to continue with more stringent standards if this were 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 might not know in advance when full accounts are needed.

It is clear that further consultation is needed before BIS can take an axe to red tape, not least because 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 appealingly easy minimum. The FRC will need to educate on this, and it may wish to remind SMEs of the commercial value of financial reporting at the same time.

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