In Australia, there are two basic frameworks to consider in order to determine whether a particular business is required to prepare Financial Reports and the standard to which those Financial Reports are to be prepared. There is the legal framework and there is the accounting framework and the table below highlights the key features of each.
| ASX Listing Rules
Corporations Act – Part 2M.3 Division 1
Other self-imposed arrangements or arrangements with financiers.
| Accounting Standards
It ought to be no revelation that there are greater accounting compliance burdens on big businesses than on small businesses. ASX-listed entities prepare glossy Annual Reports containing the Financial Reports which are audited and easily available over the internet. At the other end of the scale, small owner-managed businesses may not necessarily prepare any Financial Reports at all. Unfortunately, the legal and accounting frameworks do not always mesh well together, particularly for some ‘medium-sized’ companies which I will touch upon below.
The Legal Framework
The legal framework is predominately obtained from the Corporations Act (“the Act”). Section 292 of the Act requires certain companies (and also particular schemes and entities which I will not address here) to prepare Financial Reports. If a company is required to prepare Financial Reports under the Act, it usually has to comply with the Accounting Standards. The Act, however, does not prescribe any financial reporting requirements for unincorporated businesses operating through a trust or partnership.
Despite the potential absence of legislation which imposes requirements for financial reporting on entities such as most trusts or partnerships, there may be self-imposed requirements for financial reporting written into the formation documents, such as a trust deed, a partnership or shareholders agreement, or a company constitution. Typically, financial reporting requirements may be drafted into these types of documents intentionally to promote greater transparency between various equity providers. Occasionally, the inclusion of certain financial reporting requirements in such documents may be unintentional – usually because a pro-forma document has been adopted without proper consideration of actual needs. It is also not uncommon for financial reporting requirements to be externally imposed – eg debt providers may require a business to enter into some deed of arrangement which stipulates when and how financial reports are to be prepared.
The Accounting Framework
There are approximately 50 Accounting Standards currently in operation, many of which apply across different industries and businesses while some only apply to certain industries (eg construction or insurance). The Accounting Standards apply to all entities which are considered to be ‘reporting entities’.
Statement of Accounting Concepts SAC 1 addresses the reporting entity concept. It basically involves consideration of whether it is reasonable to expect users who are dependent on ‘general purpose financial reports’ to make informed decisions about the entity. These users typically include shareholders, employees, suppliers, financial institutions or government agencies.
The key criteria used to determine the existance of dependent users are:
a) separation of management from ownership, eg public companies;
b) economic or political importance/influence, eg public sector entites with regulatory powers, trade unions, monopoly businesses; and/or
c) financial characteristics, eg size/value of sales, debts, assets, in receipt of grants/donations, eg large charities.
Nowhere within SAC 1 or the Accounting Standards will you find a prescriptive list as to which entities are considered to be reporting entities. The legal form of the entity is irrelevant and it is ultimately a matter of judgement as to whether an entity conducting a business is a reporting entity and therefore required to prepare ‘general purpose financial reports’ which, by definition, require compliance with the Accounting Standards. Generally speaking, big businesses are reporting entities.
The ‘grey area’ between the Legal and Accounting Frameworks
Section 45A of the Act deals with proprietary companies (“Pty Ltd”). These are companies with less than 50 non-employee shareholders. Pty Ltd are classified into two distinct groups under the Act – large and small. A small Pty Ltd satisfies 2 out of the following 3 criteria:
a) Consolidated gross revenue <$25m
b) Consolidated gross assets <$12.5m
c) < 50 full-time employee equivalents at end of year
In most cases, a small Pty Ltd is exempt from preparing Financial Reports. There are a few exceptions which I will not address here. The practical result is that many small businesses (whether operating through a Pty Ltd, a partnership or a trust) do not formally prepare Financial Reports. The only external ‘carrot’ (some might argue ‘stick’) for them to do so might be to assist in the process of filing tax returns or BAS with the ATO.
Some large Pty Ltd may be caught in what may be referred to as the ‘grey area’. I referred to these earlier as ‘medium sized’ companies. These include those companies which run family owned and operated businesses which are technically considered to be large Pty Ltds under the Act. However, under the Accounting Framework, such companies would not be considered ‘reporting entities’ as there are no obvious ‘dependant users’ requiring ‘general purpose financial reports’. The outcome for some fast growing family businesses operating through one or more Pty Ltd is that they find themselves previously having been exempt from preparing Financial Reports to finding themselves now faced with preparing Financial Reports that comply with Accounting Standards and have them audited. Those businesses which face the prospect of being caught in this grey area should seek professional advice.