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New Legislation - a breath of fresh air

03 March 2014

This article first appeared in the Feb/March issue of Boardroom magazine.

The trend of legislative reform affecting directors since the finance company collapses, the global financial crisis and the Pike River tragedy has been toward sharper oversight and compliance.  Not so the Financial Reporting Act 2013 (FRA) which seeks to streamline and simplify financial reporting.

The Ministry of Business, Innovation and Employment (MBIE) expects that the FRA, which is expected to come into effect from 1 April this year, will relieve the great majority of New Zealand's 550,000 companies from the obligation to produce an annual report, delivering significant cost savings across the economy.

Who's in and who's out

Currently all companies must prepare annual financial statements - the larger ones in accordance with GAAP
(generally accepted accounting practice), and very small ones in accordance with the simpler requirements of the Financial Reporting Order 1994.

For accounting periods commencing after 1 April, financial statement preparation requirements will generally be limited to those companies which:

  • seek to raise money from the public under a regulated offer (an FMC Reporting Entity)
  • are indirectly owned by taxpayers and ratepayers, or
  • are large, because of the potential impact on society if they fail.

A company islarge for the purposes of the Act if it has assets of at least $60 million or revenues of at least $30 million a year. For the New Zealand subsidiaries of overseas companies, the thresholds are lower at $20 million and $10 million respectively.

The Act provides additional flexibility to accommodate shareholder preferences by providing that:

  • a company with ten or more shareholders can opt out of the regime on a 95 percent  shareholder resolution of those voting (unless they are FMC Reporting Entities or public entities cove red by the Public Audit Act 2001), and
  • a company with fewer than ten shareholders can be brought into the regime by notice from shareholders representing at least five per cent of voting rights.

Spreading the load

The statutory responsibility for preparing financial statements now lies exclusively with the board so if there is defective disclosure, it is the directors who are in the gun for a criminal conviction and fine of up to $100,000 each.

The new law will place the primary preparation obligation, and the liability for making mistakes, onto the company.
Consistent with the focus of the Financial Markets Conduct Act 2013, for FMC Reporting Entities, the primary recourse will be civil action, rather than criminal proceedings. The price of error can be high: three times the amount of the gain made or the loss avoided and up to $1 million for an individual, $5 million for a company.
However it should avoid the spectacle of directors of FMC Reporting Entities having to appear in District Court for a strict liability offence because that is the only avenue to redress available, even when it is accepted that there was no deliberate wrongdoing - as happened to the Feltex directors, in litigation taken by the then Ministry of Economic Development in 2010.
Criminal sanctions will now be reserved for the most egregious offences, involving intentional misconduct where a director knows that financial statements do not comply with financial reporting standards - with penalties of up to five years in prison and/or a fine of up to $500,000 for individuals and a fine of up to $2.5 million for companies.

Tax requirements

All companies will still have to report to Inland Revenue the financial data it needs for tax purposes. The IRD put out for consultation before Christmas its proposals in relation to these limited special purpose company tax filing requirements. IRD thinking is that they should be based on double entry accrual accounting and should include a balance sheet, a profit and loss statement and certain related party transactions.

Charities

Three levels of reporting will apply in the charitable sector. The External Reporting Board has prepared a simple cash-based, fill-the-box format for charities with an annualoperating expenditure of $125,000 or less and an accrual one for those with operating budgets of $125,000 to $2 million a year. Larger organisations (and they represent fewer than five per cent of the total) will be required to comply with the more sophisticated public benefit entity standards that will apply across most of the public sector.

A couple of cautions 

Although, in contrast to most of the other recent and pending pieces of legislation affecting directors, the FRA should make life easier rather than more difficult, there are still some pitfalls to be aware of.
In the absence of general purpose financial reports, it may be harder for di rectors to establish the integrity of the information they were relying upon when declaring dividends and making other decisions affecting the company's ongoing financial viability.
And, although the FRA brings the company into the frame rather than having the buck stop entirely with the director, in a situation of insolvency, the director may still be the best prospect for damages or compensation claims.
This article was written by Roger Wallis.

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