SMEs

More SMEs exempted from accounting requirements

A new EU Directive will exempt thousands of small and medium-sized enterprises from some accounting requirements. The balance sheet and turnover threshold for coverage by the existing Accounting Directives will rise by about 17%.

Internal Market Commissioner, Frits Bolkestein, said: �This will lighten the regulatory burden on thousands of smaller and medium-sized companies in the EU, while maintaining sufficient transparency and protection against fraud. Allowing small and medium-sized businesses to spend more time on creating wealth and less on administration will also give the European economy as a whole a much needed boost.�

Under the Accounting Directives, member states are permitted to grant SMEs exemptions from certain financial reporting and disclosure requirements usually imposed on limited liability companies. In addition, member states can exempt small though not medium-sized companies from publishing a profit and loss account or an annual report, from disclosing certain types of information in their accounts and from having their accounts audited. This may enable SMEs to publish only an abridged balance sheet, abridged notes to the accounts and an abridged profit and loss account.

SMEs are tightly defined by the directives. To fall within the category, companies must comply with at least two out of three qualifications. They must not have more than a certain number of employees and their balance sheet total (the value of the company�s main assets defined as the total of subscribed capital unpaid, formation expenses, fixed assets, current assets prepayments and accrued income) and net turnover (income from sales after deduction of rebates, value added tax and other turnover taxes) must be below certain figures.

The balance sheet threshold for a small company has been raised from 3.125m euros (£2.2m) to 3.65m euros and the net turnover threshold from 6.26m euros to 7.3m euros. The thresholds for inclusion as a medium-sized company have been raised from 12.5m euros to 14.6m euros for balance sheets and from 25m euros to 29.2m euros for turnover. The directive leaves the employees thresholds unchanged, at 50 to qualify as a �small� company and 250 for �medium-sized� enterprises.

The Council of Ministers has also adopted a wide-ranging directive to bring the existing Accounting Directives into line with international best practice. It complements the International Accounting Standards Regulation, adopted in June 2002, requiring all EU companies listed on a regulated market to use IAS from 2005 onwards and allows member states to extend this requirement to all companies.

It is up to individual member states to decide whether to cut the audit threshold in their jurisdictions and the UK Government has indicated that it may decide to do so. In the last Budget the chancellor spoke of the �burdensome requirements� of audits, on which he will consult this summer. For several years the Department of Trade and Industry has considered raising the turnover threshold, below which companies are not required to have an audit, from the current £1m to around £4.8m. It also called for such businesses to do without a company secretary and for a new regime for groups of companies, under which, in return for guarantees given by holding companies, the subsidiaries would no longer have to prepare or publish their own accounts.

But ACCA�s chief executive, Anthea Rose, warned that increasing the audit level - whether in the UK or across the EU - would be a dangerous move. She said that, while deregulation was an attractive concept for a government trying to improve its relations with business, it must be recognised that audit is not a waste of time or money. �It is both a valuable discipline and a guarantor of good financial housekeeping internally, and the best source of comfort for external stakeholders,� she said. �Similarly a good company secretary is needed to ensure high levels of statutory compliance.

�Lenders of finance and the tax authorities have always attached great importance to the audits of companies� accounts. The current tough economic outlook is hardly the time for less assurance to be given before lending decisions, for example, are made.�

With the statutory audit removed, the risk of fraud rises substantially, said Rose. An ACCA survey two years ago found that in 45% of cases where fraud was discovered it was the external auditors who discovered it. She added that the relaxation of audit requirements was in conflict with harsher duties on accountants to disclose breaches of money laundering regulations. Many more businesses, she pointed out, would no longer be subject to auditor inspection and would therefore escape the net of money laundering vetting.

Life insurers �creative accountancy� measured

A study by the UK�s Nottingham University has examined the �creative accountancy� used by life insurers. While the practices have disguised the difficulties many insurers face, they fully comply with the sector�s SORP.

Free asset ratios at the top 20 providers of with-profits policies fell more than three fold between 1999 and last year. Some £11bn of so-called �financial engineering� was used to protect their solvency margins and safeguard their apparent health.

Chris O�Brien, director of the Centre for Risk and Insurance Studies at Nottingham University Business School, which conducted the study, said: �The average free asset ratio fell from 9.6% in 2001 to 6.6% in 2002 (it was 22.5% in 1999) - these ratios are before the required solvency margin. However, the rules require the calculations to be on a prudent basis; �true� financial strength will be greater; and it should help when the UK FSA has completed its work on a �realistic balance sheet� for life insurers.

�The current figures are boosted by more than £11bn of what FSA calls �financial engineering�; while this raises some issues, it can also stabilise funds and improve policyholder security.�

While the average free assets ratio has fallen, all the companies had more than the minimum solvency margin required at the end of 2002, reflecting the way in which companies have been managing their businesses to take into account adverse changes in financial markets. Actions companies have taken include changing their mix of investments, arranging reinsurance, restructuring assets that were �inadmissible� and injecting new capital.

They also declared lower bonuses, although policyholders have generally fared better over the last year than if they had had wholly equity-based investments. Some companies have closed to new business.

Free assets ratio can be calculated in different ways. Nottingham University used a calculation of the excess of assets over liabilities, divided by liabilities, after subtracting the minimum solvency margin that companies are required to hold.

Ratios are also affected by companies� reinsurance and financing arrangements. This year, the FSA introduced a new form in the annual returns, giving information on �financial engineering adjustments�. These adjustments comprise implicit items, financial reinsurance, outstanding contingent loans and other charges on future profits. Although such adjustments raise some issues, they can represent prudent financial management, stabilising the fund, increasing investment flexibility and improving the security of policyholders� benefits, said Nottingham University.

Life insurers counting in significant levels of assumed future profits, according to the Nottingham survey, include Standard Life at £1.5bn in 2002 (compared with nothing the previous year); Legal & General, £1.2bn (nil in 2001); Norwich Union (part of Aviva), £976m (£1bn in 2001); Friends Provident, £600m (£600m in 2001); and CGNU (also part of Aviva), £572m (£565m in 2001). The total level of future profits counted in by the top 20 providers was £8.4bn in 2002, against £6bn the year before.