We recently reported that the Department for Business, Energy and Industrial Strategy (BEIS) had published its white paper on restoring trust in audit and corporate governance. This outlines multiple changes to the current market and has the potential to reshape the wider auditing and corporate governance system.
One focus of the white paper calls into question the current situation of dividends and capital maintenance, proposing changes to improve guidance and transparency for directors and investors. This article will explore the proposed changes that you, our valued customers, should be aware of and exactly how it could affect your business.
Why the change?
Investors are interested in whether a company can afford to pay dividends as well as retain enough funds within the business to enable long-term investment for the future success of the company.
In recent years, there have been accounting scandals involving companies such as Thomas Cook, Carillion and BHS, where significant dividends have been paid out to shareholders shortly before profit warnings, and in some cases, these pay-outs were essentially financed by large debt.
The current situation
In order to distribute dividends, a company is required to calculate its distributable profits in accordance with Section 830 of the Companies Act 2006. The Companies Act goes on to explain that these are the accumulated realised profits less the accumulated realised losses that fail to be treated as realised following principles generally accepted at the time when the accounts are prepared. For public companies specifically, they must also apply a net asset test to ensure that their net assets are not less than the aggregate of the business's called-up share capital and un-distributable reserves.
This calculation is just the first step as the directors must also consider their general duties under the Companies Act which include promoting the success of the company and their duty to exercise reasonable care, skill, and diligence.
Problems with the current situation
The calculation of distributable profits has historically been a pain point for many organisations, particularly public companies. Therefore, the Institute of Chartered Accountants in England and Wales (ICAEW) and the Institute of Chartered Accountants of Scotland (ICAS) have each issued guidance to assist in calculating these distributable profits. Although the process is by no means simplified as, for example, the ICAEW guidance 'TECH 02/17BL' runs to 173 pages.
There is also the issue of transparency. An investor cannot easily calculate distributable profits as the profit in the annual accounts does not necessarily equate to distributable profits. Also, it is not always clear if the directors have considered their need for capital maintenance to invest in the long-term success of the company.
What are the proposals?
- The government plans to set up an independent regulator: the Audit, Reporting and Governance Authority (ARGA), to either prepare guidance on distributable profits instead of the ICAEW and ICAS, or to give them the power to make these rules binding.
- The report recommends the disclosure of distributable reserves in the annual accounts of listed and Alternative Investment Market (AIM) companies, including a breakdown of realised and unrealised profits. This would mean that this number would therefore be subject to audit. This disclosure would be for individual companies as groups cannot pay dividends. A company would also be allowed to disclose a ‘not less than figure’ where it is impossible to calculate the exact figure.
- If the company is part of a group and the parent company is intending to pay dividends which include profits remitted from subsidiaries, they will also be required to disclose potential distributable profits including narrative disclosures explaining any major constraints on the subsidiaries ability to pay the parent.
- Directors’ will be required to provide a statement that any proposed dividend will not threaten the company’s solvency over the next two years and that they are satisfied that the dividend is within known distributable reserves. They must also detail that they have paid regard to their general duties under the Companies Act.
What happens now?
The proposals are due to close on the 8th of July, but in the meantime, they are open for consultation. BEIS are particularly interested in hearing the views of the following groups:
- Users of financial statements
- Investors
- Shareholders
- Business stakeholders, including creditors
- Firms regulated by the Financial Reporting Council (FRC)
- Large public and private companies, and their directors
- Other regulatory bodies, such as professional associations that represent their members’ interests
To have your say on the pending changes, head to the FRC website.
You can also download our latest white paper on audit reform in the UK to find out how the upcoming audit and corporate governance reform may affect your business.
Tina Whittington
Tina joined Ideagen in the summer of 2015 from the audit and accounting technical department of a top 10 Accountancy firm based in London. She brings with her an expertise in auditing standards and financial reporting standards, including UK GAAP and IFRS. She is the product manager for our Pentana Disclose product and writes the content for all the Pentana Disclose checklists.