Capital Maintenance – is the
current system working?
ASB Public Meeting
26 February 2008
Agenda
z
Introduction
z
Current requirements and
guidance
z
Practical issues
z
Protecting creditors
z
Conclusion
1
Agenda
z
Introduction
z
Current requirements and
guidance
z
Practical issues
z
Protecting creditors
z
Conclusion
2
Introduction
z The current system for distributions based on:
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Company law
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Directors’ fiduciary duty
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ICAEW guidance
z Complex rules predominantly to protect interests of creditors
z A number of practical issues
z Risk of paying illegal dividends
z Compliance cost is high
z New accounting framework increases risk and cost
Are the current capital maintenance rules working?
3
Agenda
z
Introduction
z
Current requirements and
guidance
z
Practical issues
z
Protecting creditors
z
Conclusion
4
Current legal requirements and guidance
Legal requirements
z Common Law - cannot make distributions out of capital
z Fiduciary duties – company must still be solvent post distribution
z Distributions only from GAAP accumulated realised profits less
accumulated realised losses
z Public companies - net assets not less than the called up share capital
and undistributable reserves.
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Current legal requirements and guidance
ICAEW guidance
z Updating guidance on realised and distributable profits
z Will not change principles - consolidate existing guidance:
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Tech 07/03 – Guidance on determining realised profits and losses in the context of distributions
under the Companies Act 1985 (as revised by Tech 02/07)
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Tech 50/04 – Guidance on FRS 17 Retirement benefits and IAS 19 Employee benefits on
realised profits and losses
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Tech 64/04 – Guidance on the effect on realised and distributable profits of accounting for
employee share schemes in accordance with UITF Abstract 38 and revised UITF abstract 17
z
Tech 02/07 – Distributable profits: Implications of recent accounting changes
z Applicable to companies preparing accounts under UK GAAP and IFRS
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Agenda
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Introduction
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Current requirements and
guidance
z
Practical issues
z
Protecting creditors
z
Conclusion
7
Issues
Determining realised profits is complex
z Guidance does not address all circumstances
z Fair values and presentational changes add to complexity
z Misalignment of accounting and legal rules
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Issues
Changing from UK GAAP to IFRS
z Proposed to change IAS 27 and IFRS 1:
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Dividends from pre-acquisition credited to income statement
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Ability to pay dividends unchanged
z Other issues remain preventing UK entities switching to IFRS:
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Volatility of reserves
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Pension accounting
z UK GAAP converging with IFRS - these issues need to be addressed
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Issues
Accounting policy changes
z May impact reserves but not underlying economics or cash position
z Change in functional currency can have a similar effect
Dividend blocks
z Intra-group movements of assets or investment impairments can block
dividends and fund movements
z Group reorganisations to alleviate are costly and time-consuming
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Issues
Tax/financial restructuring
z Despite solvency, ability to undertake restructuring may be restricted:
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Level of distributable reserves overall
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Impact on the reserves of specific entities
z Can lead to sub-optimal restructuring
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Issues
Illegal dividend payments due to technical breaches
z Technical breach renders dividends unlawful
z Directors are potentially personally liable for repaying dividend
z Examples:
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Failing to file “relevant”/interim accounts by Public companies
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Failure to prepare “relevant”/interim accounts by private companies
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Dividends not paid up a group in time
z Errors can be corrected but are costly and time consuming
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Issues
Returning capital to shareholders
z Significant restrictions on returning capital
z Companies may have insufficient distributable reserves
z Capital reductions can be undertaken to create reserves:
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Private companies - new solvency statement regime (CA2006)
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Public Companies - still require Court approval
z Expensive and time consuming
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Agenda
z
Introduction
z
Current requirements and
guidance
z
Practical issues
z
Protecting creditors
z
Conclusion
14
Protecting creditors
Protecting creditors
z Current capital maintenance regime in place to protect creditors
z Does it?
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Accumulated reserves does not mean able to pay its debts as fall due
z A solvency based system would be better for creditors but:
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Forecast cash flows depend on underlying assumptions
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Longer time period impacts reliability
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Cash flows at strategic business unit level
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Fiscal cash flows often very different due to trapped cash
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Form of statement by directors
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Sanctions in the event of subsequent failure
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Independent assurance difficult to obtain
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Agenda
z
Introduction
z
Current requirements and
guidance
z
Practical issues
z
Protecting creditors
z
Conclusion
16
Conclusion
z Accounting standards are becoming more complex - accounting and
realised profits continue to diverge
z Distributions based on ability to pay provides protection for creditors
z Solvency based system has practical and cost implications
z Change to the law and guidance should not further increase complexity
z Cost and management time need to be considered
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