Committee Reports > List of Committees > Joint > 1976 > Committee on the Secondary Legislation of the European Communities > Report No. 47 - Company Law, Annual Accounts of Limited Liability Companies

REPORT

1. Introduction

The draft Fourth Directive on Company Law deals with the annual accounts of limited liability companies. The original draft appeared in 1971 but an amended version was forwarded by the Commission to the Council in March, 1974. The amended draft takes account of opinions delivered by the European Parliament and the Economic and Social Committee as well as submissions made by the EEC Accountants Study Group. It has been for some time under examination by a Council Working Party and various amendments have been put forward at that level. The Joint Committee has considered a version of the proposal which contains the amendments which at this stage appear likely to be adopted as a result of the work of the Working Party.

2. Scope of Proposal

As is the case with the other proposals which are intended to harmonise company law in the EEC, the draft Fourth Directive is founded on Article 54 (3) (g) of the EEC Treaty.

The draft Directive deals with the content, format, filing and publication of the accounts of public and private companies. It specifies in detail the obligatory content and format of balance sheets and profit and loss accounts and requires certain information to be given by way of notes on the accounts. It provides for a management report and prescribes rules for determining valuation.

Adoption of this Directive would involve significant changes in existing Irish statutory requirements. In its examination of the matter the Joint Committee concentrated on some aspects concerning which reservations have been expressed by interested bodies in this country.

The adoption of the proposal will also have a special significance for private companies in Ireland. Under the First Council Directive 68/151/ EEC of 14 March, 1968 Member States are obliged to take measures to ensure the compulsory disclosure by companies of their balance sheets and profit and loss accounts for each financial year. However, the Treaty of Accession provided that the compulsory application of this provision to private companies in Ireland was to be postponed until the date of the implementation of a Directive regulating companies’ accounts. Accordingly, the adoption of the proposal now under consideration will bring into operation the aforementioned provision of the First Directive as far as private companies are concerned.

3. True and Fair View

The overriding requirement in Irish accountancy practice is, as required by section 149 of the Companies Act, 1963, that the annual balance sheet and profit and loss account should “give a true and fair view” of the affairs of the company and its profit or loss for the year. Article 2 of the amended draft Second Directive contains a somewhat similar requirement but as it also provides that the annual accounts “shall be drawn up clearly and in conformity with the provisions of this Directive”, the question arose as to which requirement would take precedence in the event of a conflict between them.

In the latest version of the draft it is provided that where a provision of the Directive conflicts with the “true and fair view” principle, it need not be observed subject to an appropriate explanation appearing in the notes on the accounts. The Joint Committee is informed that this new provision, if accepted, would meet the objections expressed by the Irish accountancy profession to the original draft.

4. Materiality

Associated with the “true and fair view” principle is the concept of materiality. In an accounting sense the materiality of an item is judged by reference to whether its non-disclosure would be likely to distort the view given by the accounts and also whether its inclusion would obscure the view given by the accounts. In applying the concept one need only be concerned with what is important or with what matters and one can omit unimportant items. The sixth schedule to the Companies Act, 1963 which prescribes the information to be disclosed in accounts, specifies six instances in which information if not material, need not be disclosed. The principle of materiality is however fundamental in Irish accountancy practice and is not restricted to statutory references.

To some extent the concept of materiality has been recognised in the draft Directive. Article 4(3) in the latest version would allow the grouping of certain items provided they are “immaterial” by reference to the “true and fair view” standard. Article 35 would permit assets and materials which are constantly being replaced to be shown under assets at a fixed quantity and value if their “overall value is of secondary importance”. It is possible to argue that all items which are not comprehended by these specific provisions must be regarded as material.

The Consultative Committee of Accountancy Bodies in Ireland has pointed out that while the true and fair view does demand adequate disclosure, it also demands the exclusion of irrelevant and obscuring detail. That Committee has come to the conclusion that while the profit and loss account would show little difference under the draft Directive compared with present practice, the balance sheet would contain considerable additional data to the detriment of clarity of presentation. Accordingly, it would like to see included in the Directive a general provision excluding immaterial items from its application.

In the Joint Committee’s view it should not be necessary to depart from the test of materiality as applied in present Irish accountancy if it is accepted that the true and fair view should be the paramount requirement of the Directive. If there is any doubt on this point the Joint Committee would strongly support the amendment suggested by the Consultative Committee.

5. Goodwill and Cost of Research and Development

The draft Directive provides that goodwill should be written off over a maximum period of five years. This would involve a change in both Irish law and practice and could create practical difficulties for Irish companies— for instance, those who currently carry amounts of goodwill in their balance sheets arising usually from the acquisition of shares in other companies valued on an earnings basis in excess of the value of the net assets of the company.

The Joint Committee considers that a company should be free to follow its own policy in regard to the writing off of goodwill subject to the policy followed being disclosed in the notes on the accounts.

A similar provision is included in regard to the cost of research and development which the Joint Committee considers to be too inflexible. The Joint Committee, however, notes that the Commission has suggested an amendment to the Working Party whereby Member States may “in exceptional cases” allow derogation from the writing off provisions insofar as such costs are concerned. If this amendment enables the particular circumstances of individual businesses to be taken into account, the Joint Committee would welcome it as a considerable improvement. In some businesses the cost of research and development might properly be written off at once while in others e.g. a prospecting company, the anticipated life of any mine discovered might be a sounder basis.

6. Lay-Out of Profit and Loss Account

Article 24 of the draft Directive allows Member States to permit the grouping of certain items in the profit and loss account of a company whose (a) balance sheet total does not exceed one million units of account, (b) net turnover does not exceed two million units of accounts, and (c) employees do not exceed one hundred. The Small Firms Association has suggested to the Joint Committee that the derogation should be permitted in the case of a company which satisfies two out of three of the aforementioned criteria.

The Joint Committee understands that this proposal has not met with favourable reaction in the Working Party. Nevertheless, it believes that because circumstances of concerns differ widely, it is desirable to be as flexible as possible. It would like the suggestion made by the Association to be reconsidered.

7. Disclosure of Information

While accepting that the harmonisation of company law involves a standardisation of the information disclosed by companies, the Joint Committee is concerned lest, in the process, vulnerable businesses might be compelled to disclose information to their own detriment and to the advantage of their competitors.

Article 41.9 of the revised draft Directive requires that prescribed notes on the accounts should contain a breakdown of turnover by category of products, activities and geographical markets. The Joint Committee understands that the Commission has proposed to the Working Party that the category of “products” be dropped and that Member States be permitted to allow the information regarding geographical markets to be omitted if disclosure would seriously prejudice the undertaking concerned. The Joint Committee welcomes these proposed changes.

Article 43 proposes that the annual report should give an indication of “the activities in the field of research and development and the costs thereof”. The Joint Committee finds this provision objectionable for the reasons already indicated and recommends that it be opposed.

The Joint Committee agrees with the submission of the Irish Transport and General Workers Union that the enjoyment of limited liability by entrepreneurs is a privilege for which, in return, companies should be required to make such disclosures as are desirable in the interests of creditors, employees and the general public. The Joint Committee however remains concerned at any requirement of disclosure which would be to the disadvantage of the companies and would place limitations on their contributions to the general aim of economic growth.

8. Implementation

The Joint Committee re-iterates the view expressed in its forty-second report of 30th June, 1976 which dealt with the draft Second Directive, that the Directives involving the amendment of the Companies Act, 1963 should be implemented by statute and not by statutory instruments.

When all the Directives dealing with company law are finally adopted the Companies Act, 1963 will have to be amended extensively to comply with Community obligations. It seems to the Joint Committee that at that point a suitable opportunity will arise for reviewing the provisions of the Act from the viewpoint of domestic needs as well as Community requirements. The Joint Committee considers that this work could usefully be undertaken by a joint committee of the Dáil and Seanad specially appointed for the purpose. It would obviously be of great benefit to have in a single statute all the statutory law relating to companies appropriately revised to meet all present day requirements.

9. Acknowledgements

In its consideration of the draft Directive the Joint Committee received invaluable help from the Consultative Committee of Accountancy Bodies in Ireland, the Confederation of Irish Industry, the Small Firms Association and the Irish Transport and General Workers Union and it wishes to record its thanks to those bodies.

(Signed) CHARLES J. HAUGHEY,

Chairman of the Joint Committee.

9th December, 1976.