This article has been written for our small limited company clients. There are significant changes in the rules on how Financial Statements are prepared in the UK and what must be filed on the public record at Companies House.
As a director of a limited company, you have a choice in which rules to apply and therefore exactly what must or can be filed at Companies House for your company.
As well as proving details of the changes, we hope that this article will also explain what is currently prepared, filed and provided to H M Revenue & Customs and Companies House.
The decision of what type of Financial Statements to prepare is simple for most small companies, but for some it may be more difficult. It can be a trade-off between preparing more useful Financial Statements (full of disclosure about activities, profitability, financial position and showing the directors’ remuneration and dividends) and preparing and filing much simpler Financial Statements.
If your company needs to apply for credit or to provide a bank or other providers of finance with more detailed information then you may be pushed towards preparing fuller Financial Statements and consequently disclosing more on the public record.
A bit of background to UK companies and their annual Financial Statements
The directors of a company are responsible for preparing the annual Financial Statements of the company. The Financial Statements include a Profit & Loss Account, a Balance Sheet, a Directors’ Report and a whole host of notes and other disclosures.
If you have ever received the Financial Statements of a Public Limited Company (plc), i.e. all those multinational companies quoted on the Stock Exchange, then they will have made a large thud as they fell on your doormat.
For many years, the smallest companies in the UK have followed special rules that determined how their annual Financial Statements were prepared and what must be disclosed. Accordingly, the Financial Statements of these companies are significantly shorter and typically made up of about 20-25 pages.
These Financial Statements must be prepared by the directors for the shareholders of the company, which for the smallest of owner managed businesses are often the same people. Accountants have often called these the ‘full’ Financial Statements of the company. The full Financial Statements are also filed with H M Revenue & Customs.
Companies are also required to file their Financial Statements with Companies House. Companies House is a government agency whose function includes receiving and making available to the public the annual Financial Statements of UK companies. Directors have the option of preparing an extra, but much shorter, set of Financial Statements known as Abbreviated Accounts, and filing these at Companies House.
Abbreviated Accounts are typically prepared and filed by all small companies allowing reduced disclosure on the public records at Companies House about the financial position and profitability of a company. Abbreviated Accounts, for small companies, need only include the Balance Sheet and a few notes on fixed assets movements, share capital and any amounts outstanding on overdrawn directors’ current accounts. In other words, they do not show the turnover, expenses or profit of the company nor the dividends or salaries of the shareholders and directors of the company.
Change in the UK accounting rules
For accounting periods commencing on or after 1 January 2016, small companies are no longer be permitted to prepare their accounts in accordance with the Financial Reporting Standard for Smaller Entities 2015 (FRSSE 2015). Instead they will need to change to one of the new UK GAAP (Generally Accepted Accounting Practice) alternatives.
The FRSSE was originally issued in November 1997. It has been updated every few years since then, to keep up with changes in GAAP issued by both the UK and international accounting bodies. The latest version is FRSSE 2015.
FRRSE 2015 has become the ‘rule book’ on how a set of Financial Statements for the smallest of limited companies should be prepared. It has specified the presentation and disclosures rules and how all aspects of accounting transactions should be valued and quantified in small company annual Financial Statements. It has therefore been the set of rules that small company accountants have used for two decades.
FRS 102 is a new suite of accounting requirements which are closely aligned to, but are not the same as, International Financial Reporting Standards (IFRS).
Section 1A of FRS 102 is available to small companies and is aligned to FRS 102 but with reduced disclosures and presentation requirements.
FRS105 is an accounting standard available to the very smallest of companies and permits even further reduced disclosures and presentation requirements than that of FRS 102 Section 1A.
What is changing for small companies?
All companies must now decide which rules they wish to use to prepare their annual Financial Statements. Just because the directors manage a small company does not mean that they cannot prepare their annual Financial Statements using full IFRS or FRS 102, like very large companies.
The purpose of this article is not to examine all the changes nor all the differences between IFRS, FRSSE, FRS 102, FRS 102 1A or FRS 105.
Most small companies that currently use FRSSE 2015 are expected to change to using Section 1A of Financial Reporting Standard 102 (FRS 102 1A) or, for the very smallest of companies, the Financial Reporting Standard Applicable to the Micro-entities Regime 105 (FRS 105).
Most of our smaller limited company clients would not notice too much difference in the presentation of the Financial Statements prepared under FRS 102 1A and those under FRSSE.
H M Revenue & Customs will still receive a copy of the Financial Statements, whatever rules they are prepared under, when the Corporation Tax return is filed each year.
The biggest decision for directors of small companies is to decide what they wish to file at Companies House. For accounting periods commencing on or after 1 January 2016, Abbreviated Accounts can no longer be prepared. From that date, companies must file at Companies House what they prepare for their shareholders.
The concept of preparing full Financial Statements for the shareholders and H M Revenue & Customs and then another reduced disclosure set (Abbreviated Accounts) for Companies House has now ended for all companies with accounting year-ends after 31 December 2016. It should be noted that the new rules actually apply to accounting period starting after 1 January 2016. Therefore, for short periods of account, for say six months to 30 June 2016, the new rules are already effective.
Companies will now have to file what they prepare. There is now only going to be one set of Financial Statements. This is a radical change in company law.
There is some relaxation in filing requirements for small companies. However, before we mention them, we need to outline a few concepts and definitions.
What is a UK small company?
A small company is defined as one that meets at least two out of three of the following:
Turnover is not more than £10.2m
Balance Sheet total assets are not more than £5.1m
Average number of employees is not more than 50
As can be seen, small companies can still be very large companies.
What is a micro-entity company?
These are the very smallest of companies and defined as one that meets at least two out of three of the following:
Turnover is not more than £632,000
Balance Sheet total assets are not more than £316,000
Average number of employees is not more than 10
What will the Financial Statements of a small company look like?
This depends what accounting rules the directors decide to follow.
Fuller Financial Statements
Whether the directors use IFRS, FRS 102, FRS 102 1A, the basic Financial Statements and disclosures will include:
Accountant’s Report
Directors’ Report
Profit & Loss Account (showing turnover, cost of sales, gross profit, total overheads, other operating income, profits before tax, tax charge and profits after tax)
Balance Sheet (showing fixed assets, stocks, debtors, cash at bank, creditors, share capital etc)
Notes to the Profit & Loss Account (showing directors’ remuneration, dividends etc)
Notes to the Balance Sheet (showing a detailed breakdown of fixed asset movements, debtors and creditors in more detail together with share capital, movement on reserves etc)
Other notes (showing accounting policies, controlling parties, related party transactions, employee numbers etc)
Most accountants include a detailed Profit & Loss Account at the back of the Financial Statements. This shows a more detailed breakdown of the overheads of the business e.g. wages and salaries, motor running costs, light and heat, repairs, insurance and legal and professional costs etc. These are not part of the statutory Financial Statements. It does not have to be provided to the shareholders and does not have to be filed at Companies House. However, the information is filed with H M Revenue & Customs.
The examples above in brackets just give an outline of items included. The notes to the Financial Statements could also include a detailed breakdown of turnover, make-up of the tax charge, nature of any revaluations of fixed assets, details about going concern, contingencies and capital commitments.
Micro-entity Financial Statements
If the company is eligible, and the directors elect to adopt FRS 105, then the company may prepare micro-entity Financial Statements that will include:
An Accountant’s Report
A Directors’ Report (optional)
A Profit & Loss Account (showing turnover, cost of raw materials, staff costs, depreciation, other charges, tax charge and profits for the year
A Balance Sheet (total fixed assets, total current assets, total current liabilities, and total capital and reserves)
There are absolutely no notes to the Financial Statements. Notes provide more details to the Profit & Loss Account, Balance Sheet and other disclosures.
If applicable, extra disclosure is required at the foot of the Balance Sheet for possibly ‘minimum accounting items’ like guarantees, director’s overdrawn loans and financial commitments)
The format of the Profit & Loss Account is very short, and in the opinion of most accountants not very helpful. The Balance Sheet is similarly made up of totals and little detail.
Fixed assets cannot be included in the Financial Statements at a revaluation and deferred taxation cannot be used in the Financial Statements.
Filing requirements for small companies
Abbreviated Accounts have disappeared for all accounting periods starting after 1 January 2016, which in practice means for all accounting periods of one year or more, for all year ends of 31 December 2016 and after.
As noted above, only one set of Financial Statements is now prepared. We have a new concept of ‘file what you prepare’. In other words, what is prepared for the shareholders under GAAP and the Companies Act 2006 is what is now filed at Companies House.
There are a few relaxations for small companies in what may be filed at Companies House. The directors can decide to ‘fillet’ the Financial Statements. This literally means that certain pages are removed from the Financial Statements when deciding what will be filed at Companies House.
The company can fillet, i.e. remove, any of the following:
Directors’ Report
Profit & Loss Account
Notes directly related to the Profit & Loss Account
What is the difference between filleted Financial Statements and Abbreviated Accounts?
Some readers of this article may therefore ask, what is the difference between filleted Financial Statements and Abbreviated Accounts? The answer is that all the notes to the full Financial Statements, except a few minor notes directly related to the Profit & Loss Account, are now included in the filleted Financial Statements filed at Companies House.
Therefore, the following are shown in the filleted Financial Statements filed at Companies House that were not previously filed under the Abbreviated Accounts regime:
full breakdown of stocks *
full breakdown of debtors *
full breakdown of creditors *
related party transactions
dividends paid *
employee numbers
directors’ remuneration
movements on reserves *
any other notes *
* = A small entity is required to present sufficient information in the notes to its Financial Statements, and therefore in the copy filed at Companies House, to enable the Financial Statements to give a true and fair view of the assets, liabilities, financial position and profit or loss of the company for the year. As such small companies are therefore encouraged to make those disclosures that are relevant to material transactions in order to give a true and fair view of the Financial Statements.
The first two items may not seem an issue. The creditor’s note will show the Corporation Tax creditor. So, if this shows £20,000 as due in Corporation Tax, then at a Corporation Tax rate of 20%, the company must have made around £100,000 in profit. That is often regarded as private information and not for the public record.
The related party transactions note will show material transactions with specified parties, e.g. the directors, their close family and related companies, which have not been conducted under normal market conditions. This could therefore require disclosure of sales and purchases with the company, charges to the company, e.g. home as office rental charges, and balances outstanding at the year-end e.g. the director's loan account balance. An interest free director's loan account will therefore not be conducted under normal market conditions and would require disclosure if material.
Dividends paid will clearly show how much of the profit has been paid out to shareholders.
In any case, transactions with directors that require disclosure include directors’ remuneration (salary, pension and benefits in kind) and dividends paid to them.
The effective disclosure of the company’s profits, together with dividends declared and directors’ remuneration paid in the year, will be a great shift in disclosure requirements.
Is FRS 105 the answer to reduced disclosure for the smallest companies?
For the very smallest of companies, including smaller owner managed businesses and personal service companies, there is a way to avoid disclosure of the company profits and the directors’ dividends and remuneration.
The answer is for the directors of the company to adopt FRS 105, ‘Financial Reporting Standard Applicable to the Micro-entities Regime’ as their basis for preparation of the annual statutory Financial Statements.
FRS 105 Financial Statements are made up of a Directors’ Report (optional), Profit & Loss Account and Balance Sheet. There are no notes, so the directors’ remuneration, dividends paid and balances outstanding at the year-end are not shown.
When it comes to filing the Financial Statements with Companies House, the directors can fillet the FRS105 Financial Statements and therefore remove the Directors’ Report and Profit & Loss Account.
What is effectively left in the FRS 105 Financial Statements to be filed at Companies House is just the summary Balance Sheet of the company together with possibly ‘minimum accounting items’ like guarantees, directors’ loans and financial commitments. Because of the lack of information, and in particular no notes to the FRS 105 Financial Statements, it can be difficult to fully understand the profitability and financial position of the company.
Probably most directors of the very smallest of companies do not really understand the Financial Statements that are prepared. Therefore, deciding to follow the FRS 105 rules will not cause too much concern and will also significantly reduce the disclosure of information at Companies House compared with what was previously filed under the former Abbreviated Accounts regime.