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Start / ... / June 2005 / Company Law and Accounting Changes

The legal framework under which companies prepare their accounts has changed significantly in recent months. This purpose of this article is to summarise the main changes and highlight for readers the main impacts likely on financial statements. [Tables and illustrations have been omitted from the online version of this article]

Company Law was amended to give effect to three major pieces of EU legislation (See Table 1).

FAIR VALUE REGULATIONS Just before the end of 2004, two statutory instruments transposed into Irish law the requirements of the EU Fair Value Directive for companies governed by the 1986 Act1 and the Group Accounts Regulations2 and also credit institutions governed by the Credit Institution Regulations3 .

Use of fair value for financial instruments The main purpose of this EU Directive was to amend earlier EU Directives in such a manner as to permit the EU to endorse IAS 39 on the fair value measurement of financial instruments. Unfortunately, the EU Fair Value Directive was drafted based on an earlier version of IAS 39 than that subsequently endorsed by the EU. This has led to a number of anomalies and the following tables set out the differences between what is permitted to be fair valued through profit or loss or directly to fair value reserve under our Fair Value Regulations and under the international financial reporting standards currently endorsed by the EU.

The discrepancies here should not be too much of a problem for most companies but could be problematical for credit institutions. It would be reasonable to expect that the true and fair override in law could be used to apply the full choices permitted under the EU endorsed IFRS where these were necessary for a true and fair view. At present, under the law and the EU endorsed IAS 39, liabilities, other than derivatives and trading instruments, may not be accounted for at fair value even though the full IAS 39 issued by the IASB allows that treatment. This difference between the IASB standard and the EU endorsed standard has been the subject of serious debate for some time. It is now expected that the IASB will issue an exposure draft restricting the use of the fair value option to certain circumstances. If this amendment to IAS 39 is approved, it is likely that the EU will endorse it.

Directors' Reports Apart from the ability to fair value certain items through profit and loss account, the Fair Value Regulations also amended disclosure requirements in the Directors' Reports of Irish companies. These additional disclosures are quite extensive and have perhaps not got as much attention as they deserve. These Regulations require that the Directors' Reports of companies, other than small and medium sized companies, must provide the following information: - An analysis of the financial risk management objectives - The policy for hedging each major type of forecasted transactions for which hedge accounting is used, and - A discussion of the exposure of the company and group to price risk, credit risk, liquidity risk and cash flow risk. These Regulations also introduced significant additional disclosures about financial instruments which need to be made whether or not fair value through profit and loss account is adopted by companies.

IFRS REGULATION This Regulation became part of Company Law in Ireland earlier this year. It deals with both the EU IAS Regulation and the EU Modernisation Directive.

EU IAS Regulation This EU Regulation made it mandatory for all listed entities in the EU to prepare their group accounts in accordance with IFRS for all accounting periods beginning on or after 1 January 2005. There were a number of Member State options available in the Regulation and the following were the choices reflected in Irish law: - The effective date for debt listed parent companies was deferred to accounting periods beginning on or after 1 January 2007, and - All other Irish companies have the option to use IFRS in preparing their group and individual accounts. Therefore all companies and groups (that are not directly impacted by the EU IAS Regulations) have a choice in future as to the financial reporting framework that they apply in preparing their individual and group accounts. There are now two financial reporting frameworks that are available for accounting periods beginning on or after 1 January 2005. These are: - Companies Act accounts - IFRS accounts 'Companies Act accounts' are accounts prepared in accordance with the formats and accounting rules of Irish company law and accounting standards. The applicable accounting standards are the Financial Reporting Standards issued by the Accounting Standards Board in the UK. The type of entity will determine which company law rules apply, (e.g. is the company within scope of the 1986 Act, the Group Accounts Regulations, the Credit Institution Regulations, the Insurance Undertaking Regulations, etc?) 'IFRS accounts' are accounts prepared in accordance with International Financial Reporting Standards issued by the IASB and the following mandatory disclosures carried forward from Irish company law requirements: - Director's remuneration - Transactions with Directors - Directors' interests in shares and ventures - Names and other details of group undertakings - Staff numbers and remuneration - Share capital and debentures - Restrictions on distributability of profits because of own shares held - Guarantees and other financial commitments - Loans relating to financial assistance for purchase of own shares - Shares and debentures of the parent held by subsidiary undertakings - Auditors' remuneration Generally speaking, the move from Companies Act accounts to IFRS accounts is a one way street and only with 'relevant changes in circumstances'4 can a company revert to preparing Companies Act accounts.

The IFRS Regulation also imposed consistency requirements on the directors of a parent company that prepares group accounts. It requires that they should ensure that the same financial reporting framework is used in the individual accounts of the parent entity and in the individual accounts of all subsidiaries.

There are a few limitations to this consistency requirement. Firstly, it applies only to parent companies that prepare group accounts; secondly, it applies only to Irish subsidiaries; and thirdly, it applies unless there are “good reasons” (which need to be disclosed) for doing otherwise. There is also an exemption in that the individual accounts of the parent entity can follow the framework used in the consolidated accounts where the consolidated accounts are prepared using IFRS. In summary, Table 4 sets out the options available to groups.

It should be noted that the parts of company law that do not deal with the preparation of accounts still continue to apply to all Irish companies regardless of which financial reporting framework they apply to their accounts. Therefore current requirements regarding the filing and signing of accounts, the rules regarding redemption and purchase of own shares or financial assistance for purchase of own shares and the rules regarding distributions still continue to apply to IFRS accounts.

Perhaps the question that most regularly arises is the impact on profits available for distribution. The rules regarding distribution set out in the 1983 Act5 are unchanged by the new legislation. However the 'relevant accounts' referred to in that section may now be IFRS accounts and not Companies Act accounts. The company law accounting rules generally state that only 'realised' profits may be included in the profit and loss account of Companies Act accounts (there are some exceptions introduced by the Fair Value Regulations) but IFRS permit many unrealised gains to be included in the income statement of IFRS accounts.

However, profits available for distribution will still comprise only realised profits less losses. The meaning of 'realised' has not been changed and in essence an item is only realised when it has passed out of a company's control and the company has received cash or cash equivalents in return for it. Consequently, it will be important in future for companies to track the extent to which profits recognised in their IFRS accounts (or Companies Act accounts) are in fact realised.

EU MODERNISATION DIRECTIVE The IFRS Regulations referred to above also transposed this Directive into law in Ireland. It is Irish company law that has changed and therefore these changes impact on all accounts whether they are being prepared as Companies Act accounts or IFRS accounts. The following paragraphs highlight the main areas that have changed.

Director's Reports There have been significant changes to the requirements of what must be disclosed in a Directors' Report. The IFRS Regulation extends the fair review of the development and performance of the company to include a requirement to describe the “principal risks and uncertainties” facing the company and its subsidiaries. This review is required to be a balanced and comprehensive analysis of development and performance consistent with the size and complexity of the company or group. It also goes on to require that, to the extent necessary to understand the company's development, performance or financial position, it must include an analysis of financial and, where appropriate, non-financial key performance indicators relevant to the business including environmental and employee data.

There is an exemption available for small and medium sized companies from giving the disclosures regarding key performance indicators. However they must still describe the principal risks and uncertainties. It must be noted that there are no exemptions available for subsidiaries even if group accounts are prepared.

New Accounting Principle The accounting principles underlying Irish company law have been changed to include a new principle which requires that in accounting for a transaction the substance of the transaction and not just its legal form should be considered.

Definition of Subsidiary The definition of a subsidiary in Irish law and in particular in the Group Accounts Regulations, Credit Institution Regulations and Insurance Undertakings Regulations has been changed. In the past where a company actually exercised dominant influence over another company or was managed on a unified basis with that other company it was necessary for the company to have a participating interest (ie a long term interest in the share capital) in the other company before it met the definition of a subsidiary. The requirement to have this participating interest has been removed and a company will now be the subsidiary of another company where that other company has the power to exercise, or actually exercises dominant influence or control over it or where that other and the subsidiary are managed on a unified basis. Preparers need to reassess the constituent elements of groups to ensure that all new subsidiaries are identified.

Proposed Dividends The timing of the recognition of proposed dividends has changed. Under the new law a proposed dividend will not be considered a liability until the approval process is complete. Consequently, dividends proposed to the shareholders for approval at the AGM will not be a liability in the accounts of the entity at the end of the financial year. They will merely be separately disclosed in the notes. Reconciliation of Profit and Loss Account Reserve In the past the reconciliation of profit and loss account reserve has been given on the face of the profit and loss account. This has now been amended and the reconciliation must be given in the notes to the accounts.

Abridging Accounts It has always been possible for small and medium companies to abridge the full Companies Act accounts for the purposes of filing those accounts for the public record. For small companies the abridged accounts included just a balance sheet and certain notes to those financial statements. For medium sized companies, the abridged financial statements effectively included the full set of accounts except that information regarding turnover and cost of sales did not have to be provided separately and the profit and loss account could start with gross profit. Similar abridgement will be possible even where the full accounts are prepared under IFRS.

CONCLUSION This article is a very brief introduction to the recent changes introduced into Irish company law. As you can see there are significant changes which impact on companies regardless of whether or not they chose to prepare their financial statements under IFRS. It is important that preparers are aware of these changes and take the necessary steps to be ready for year ends of December 2005 and later.

Notes 1 Companies (Amendment) Act 1986 2 European Communities (Companies:Group Accounts) Regulations 1992 3. European Communities (Credit Institutions:Accounts) Regulations 1992 4 See amended section 148(5) of the Companies Act 1963 5 Companies (Amendment) Act 1983

Úna Curtis, FCA, is Director of Professional Standards, KPMG.

thanks Una for this article. Where would be the most useful place to get a pro-forma of a set of abridged accounts? We need to file a company return and set of accounts with the Collector General so your help in this matter will be greatly appreciated.

To whom it may concern can someone guide me where to find the 3obligations of which two must be met for a company to publish the full set of accounts or not. Thanking you in advance

Is there a new requirement for all committee members to become Directors. The Committee that I am a member of looks after a Community Centre and is limited by guarantee and not having a share capital. I am being pressed to sigh the B10 form. Your help will greatly appreciated. Thank you.