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Brief Counsel

Nasty surprise for large private entities in Financial Reporting Review

21 October 2009

Large private companies and partnerships will be required to file public annual financial statements under a proposal from the Ministry of Economic Development (MED) in a discussion document released last month on the statutory framework for financial reporting. 

A similar idea was shot down when raised by MED in 2005. 

The recommendation is likely to be the most controversial among the suite of recommendations the MED is proposing, not least because it is the only one which will have the effect of increasing reporting requirements and compliance costs. 

Submissions close on Friday, 29 January 2010.

The nasty surprise 

The proposal is that “economically significant” non-issuer commercial entities, whether a company or a partnership, be required to file General Purpose Financial Reports (GPFR) each year with the Registrar of Companies.   

To qualify as large, the entity must have any two of the following (although feedback is being sought on whether these criteria are appropriate):

  • total assets of at least $10 million

  • consolidated annual revenues of at least $20 million, and/or

  • at least 50 full time equivalent employees.

This is more extensive than the proposal in 2005 in that it will apply to partnerships as well as to private companies.  However the MED is seeking comment on whether New Zealand should follow the Australian example and “grandfather” from the public reporting requirements those entities which are already in existence when the new law takes effect. 

Rationale for the proposed new reporting requirement

The rationale MED offers is:  “Large entities can have a significant impact on the national or regional economy if they fail.  Therefore, there can be a broad societal interest.  This is particularly important for suppliers who extend credit to facilitate sales, customers who prepay for goods and services and employees who have part of their compensation deferred.”

MED estimates that the change will capture around 2000 entities.  The estimate is based on Australian figures adjusted for New Zealand and is ball-park only (MED says the actual number could be half or double).

Interestingly, there is no mention of this recommendation in the press statement Commerce Minister Simon Power released to announce the review.  Instead he confined his comments to those reforms which will reduce the compliance costs for small to medium sized enterprises or will remove inconsistencies among the reporting requirements imposed by different statutes.

Chapman Tripp’s view

The proposal generated significant concern among the private business sector when last raised and we expect a similar reaction this time.  It represents:

  • an unwarranted intrusion of privacy

  • an unnecessary imposition of compliance costs, and

  • a disincentive to invest in New Zealand.

A New Zealand-owned company which does not issue securities to the public is accountable for its financial performance only to its shareholders.  Stakeholders’ interests are legitimate but they are not fundamental.  Ultimately it is the shareholder’s capital which is at risk. 

Further, our clear advice from clients in 2005 was that public disclosure of their financial statements would cause their company detriment:

  • investment and other companies advised that their ability to do business in New Zealand would be compromised as the information which could be extracted from their financial statements (for example, their capacity to take on further debt to finance an acquisition) could be used against them in competitive investment situations.  Indeed some said they would contemplate shifting off-shore were the potential changes to become law

  • highly-mobile individuals, concerned at the personal privacy and safety implications, commented that they would migrate their businesses, and

  • many commented that a private company’s balance sheet is, in and of itself, a valuable asset, and forms a integral part of a company’s knowledge capital.  Access to these accounts is often a key bargaining chip in merger-and-acquisition scenarios.

A grandfathering arrangement similar to Australia’s would provide some comfort.  But in our view, for the reasons discussed above, there is no justification in principle for the change.  Further, it is not good law to draw a distinction between entities based solely on when they came into being. 

Influencing the decision-making process

Chapman Tripp assisted clients with submissions on this issue in 2005 and was instrumental in persuading then Commerce Minister Pete Hodgson to toss out the proposal before decisions were made on the rest of the 2005 reform package. 

The arguments Hodgson offered to Cabinet for his decision were that the additional disclosure would not be “of any great value to potential users” because:

  • banks and other major lenders could demand whatever financial information they needed to decide a loan application

  • GPFR were not used to any significant extent by potential creditors or credit agencies, and

  • employee interests were protected by the Employment Relations Act.

The rest of the package

Most of the other proposed reforms will have the effect of reducing compliance costs and are in our view sensible moves in the right direction.  The recommendations in summary are to:

  • remove the requirement to prepare GPFR for all private sector for-profit entities other than those which issue securities to the public, or are large, or have a strong separation between management and owners.  (MED estimates the potential compliance savings at between $75 million and $300 million a year)

  • remove the filing requirements for overseas-incorporated companies carrying on business in New Zealand that are not issuers and/or whose New Zealand businesses are not large

  • introduce new default rules that will apply to for-profit entities that are not issuers and/or large:

    • entities with a significant level of separation between owners and management (e.g. companies with at least ten shareholders) would be required to prepare audited GPFR and make them available to owners (with owners having the choice to opt out of an assurance engagement or to opt out of preparing GPRF altogether)

    • all other entities would not be required to prepare GPFR (or obtain assurance) except if shareholders require them.  (They would still be required to keep proper accounting records and would be required to prepare accrual-based financial reports to a minimum standard for special purpose reporting, e.g. tax depreciation rates)

  • update the employee remuneration reporting requirements applying to companies’ annual reports, either by increasing applicable thresholds (from $100,000 to $150,000 or $200,000) and band sizes ($25,000 rather than $10,000), or moving to an outcomes-based approach, and

  • consolidate all standards related responsibilities within the Accounting Standards Review Board which would be renamed the External Reporting Board.

While not making recommendations, MED also seeks submissions on:

  • whether companies with one or more subsidiaries should continue to be required to prepare parent-only financial statements in addition to consolidated financial statements, and

  • whether current deadlines for filing audited financial statements (five months and 20 working days within year end) should be reduced to four months within year end.

MED’s proposals do not address the status of companies (other than issuers) that are subsidiaries of companies or bodies corporate incorporated outside New Zealand.  Currently, such companies are required to prepare and file audited GPFR whether they are large or not.  In our view, these companies should not be required to prepare and file GPFR simply because they are foreign-owned.

Where to from here

The reforms canvassed in the review have the potential to directly and deeply affect a large number of businesses – many for the better but also a significant number for the worse in terms of compliance costs.

We urge you carefully to consider the implications for your business and to take appropriate action. 

Chapman Tripp stands ready to provide assistance and is particularly well-equipped to assist as we can draw on our experience from 2005.  For further information, please contact the lawyers featured.

Contacts