The Government is set to implement a new financial reporting regime from April this year. Once in force, the new regime will make some significant changes to the existing framework for preparing, registering and auditing financial statements. This FYI discusses the key changes, particularly for issuers (or ‘FMC Reporting Entities’ under the new regime) and companies.
The six highlights of the new regime are as follows:
- Fewer small-to-medium sized New Zealand-owned companies will be required to prepare general-purpose financial statements.
- Overseas companies and subsidiaries of overseas companies no longer need to prepare, audit, and register general-purpose financial statements solely because of their overseas ownership.
- If general-purpose statements are prepared for a group, the parent is no longer required to separately prepare general-purpose statements.
- A lower standard of financial reporting will apply if general-purpose statements are not required. This will be set by the External Reporting Board.
- The deadline for FMC Reporting Entities to prepare, register, and audit financial statements is now four months after the balance date. For companies that are not FMC Reporting Entities, the deadline is five months after the balance date.
- FMC Reporting Entities will be subject to the enforcement and liability provisions of the Financial Markets Conduct Act 2013 where there is non-compliance with the new regime.
Why is it changing?
The key objective of any financial reporting system is to provide information about an entity’s finances if there is a need for the information, but no power to demand it, in a form that is fit-for-purpose.
The main problem with the existing regime is that the onerous requirement to prepare general purpose financial statements is too far-reaching. This requirement often applies in circumstances where a more limited and specific disclosure regime would suffice. The new regime is designed to fix this problem by tailoring financial reporting requirements to particular types of entity. The new regime requires general purpose financial reporting only when that is in the public interest.
The Government has focused on three indicators in assessing whether general-purpose financial reporting is in the public interest:
- when an entity is accountable to the public, eg Government departments, Crown entities, entities that raise funds from the public, banks, and insurers;
- when an entity is economically significant or ‘large’, given they can have a significant social or economic impact if they fail; and
- when there is separation between ownership and/or membership of an entity and its management, such that some owners/members will have no direct right to an entity’s financial information through also being involved with its management.
In broad terms, if one or more of these indicators applies then an entity will need to prepare general-purpose financial statements under the new regime. Where none of the indicators are present, eg a non-large, closely-held overseas company (which would need to prepare general-purpose statements under the existing regime), the entity need only prepare specific financial statements for tax purposes. At least, that is the theory.
How is it changing?
The key changes are as follows:
Financial reporting requirements in entity-specific legislation
The most obvious change is where to find an entity’s financial reporting requirements. Where you would once look to the Financial Reporting Act 1993 (1993 Act), you now look to the statute governing the relevant entity. For instance, companies look to the Companies Act 1993, FMC Reporting Entities (a new defined term, discussed further below) look to the Financial Markets Conduct Act 2013, limited partnerships look to the Limited Partnerships Act 2008, and so on. Provisions that are generally applicable will be set out in the Financial Reporting Act 2013, such as the definitions of ‘financial statements’, ‘group financial statements’, ‘large’, and ‘generally accepted accounting practice’.
Fewer entities required to prepare general-purpose financial statements
Another key change is that fewer entities will need to prepare general-purpose financial statements.
Only ‘FMC Reporting Entities’ (discussed below), ‘large’ entities, public entities, companies with 10 or more shareholders that have not opted out of compliance, and companies with fewer than 10 shareholders that have opted into compliance will need to prepare these. This is in line with the three indicators referred to above. As a consequence, overseas companies will no longer have to prepare general-purpose statements merely because of their overseas ownership.
The new regime also changes the approach to group financial statements. Whereas the 1993 Act requires a parent company to separately prepare accounts even when group accounts are prepared, the new regime does away with this requirement. Parent companies will instead have specific reporting obligations determined by the External Reporting Board. These have not yet been developed.
These changes are intended to reduce compliance costs. This will be good news particularly for small-to-medium sized businesses.
‘FMC Reporting Entity’
‘FMC Reporting Entity’ will cover more entities than are covered currently as ‘issuers’ under the 1993 Act. ‘FMC Reporting Entity’ includes issuers of financial products, all registered banks, buildings societies, and credit unions (not just some building societies and credit unions as was the case under the 1993 Act), and certain entities licensed by the Financial Markets Authority (FMA). However, companies issuing voting shares in themselves that have fewer than 50 shareholders or 50 share parcels are excluded from this definition. This is a change from the existing exception to the term ‘issuer’, which only applies to companies having fewer than 25 shareholders.
The definition of ‘large’ has also changed. There are different tests depending on whether the entity is a New Zealand or overseas company.
A New Zealand company that is not a subsidiary of an overseas company will be large if one of the following applies:
- As at the balance date of each of the two preceding accounting periods, the total assets of the company and its subsidiaries (if any) exceed $60 million (Asset Test).
- In each of the two preceding accounting periods, the total revenue of the company and its subsidiaries (if any) exceeds $30 million (Revenue Test).
For an overseas company, or a New Zealand subsidiary of an overseas company, the Asset Test is reduced to $20 million and the Revenue test reduced to $10 million.
Fewer entities required to audit and register financial statements
The new regime also requires fewer entities to register their financial statements with the Companies Office. The only entities obliged to register will be FMC Reporting Entities, large overseas companies, and large New Zealand companies with 25% or more overseas ownership.
All entities that are required to register will need to have their financial statements audited, as is currently the case under the 1993 Act. In other cases, auditing will only be required for large New Zealand companies (not having 25% or more overseas ownership) that have not opted out of compliance, public entities, companies with 10 or more shareholders that have not opted out of compliance, and companies with fewer than 10 shareholders that have opted into compliance.
Opting in and out
There will be specific provisions covering opting in and out of the requirements to prepare, audit, and register financial statements, but only for certain entities. Opting in will be allowed for small–to-medium sized companies with fewer than 10 shareholders. Opting out will be allowed for companies with more than 10 shareholders that are neither public nor large. In addition, private large companies may opt out of the audit requirement if they are not otherwise required to register financial statements. In all cases, opting out will be subject to an entity’s constitution.
These provisions will give minority shareholders a say in whether an entity chooses to prepare and audit its financial statements, particularly when the entity has fewer than 10 shareholders.
Single deadline for preparing, auditing, and registering financial statements
The deadline for preparing, auditing, and registering financial statements has also changed. For FMC Reporting Entities, there will be a single deadline of four months after the balance date, rather than the current five months for preparation and 20 working days after that for auditing and registration. For companies that are not FMC Reporting Entities, however, there will be a single deadline of five months after the balance date.
Consequences of non-compliance
Non-compliance is treated much more seriously under the new regime. This is particularly the case for FMC Reporting Entities and their directors, which will be subject to the liability and enforcement provisions of the Financial Markets Conduct Act 2013. FMA will have the power to issue stop orders, direction orders, and infringement notices when requirements are not met. There are also important changes to relevant penalties, with civil penalties ranging from $600,000 to $5 million. Criminal liability for FMC Reporting Entities can extend from ‘speeding ticket’ offences with a fine of up to $50,000, to knowing or reckless breaches carrying a fine of up to $500,000 and up to five years in prison for an individual and up to $2.5 million in fines for an entity.
When is it changing?
The only provision currently in force relates to the External Reporting Board’s power to issue reporting, auditing, and assurance standards. The substantive requirements for FMC Reporting Entities and companies will likely come into force on 1 April this year, so as to coincide with the Financial Markets Conduct Act 2013 coming into force. The balance of the Acts will come into force gradually from then on dates to be appointed by the Governor-General, with a longstop date of 1 April 2017 to the extent the Acts are not already in force.
There are provisions which guide the transition from the old regime to the new regime. Generally speaking, the new regime will apply to entities with accounting periods commencing after the new regime comes into force. Until then, the 1993 Act will apply.
Talk to the experts
There are high hopes the financial reporting changes will improve the financial reporting system. With requirements being more specifically tailored and in the case of FMC reporting entities, enforced with greater penalties, it is important that you be aware of the changes and how they might affect you.