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In search of financial reporting relief

Feature Articles

Cite as: (2003) 77(8) LIJ, p.54

There is no easy way of obtaining relief from preparing financial reports and directors' reports and having reports audited.

By Gerard Kennedy

Lawyers are often asked, in a broad-brush context, to advise companies on how to avoid having to prepare and file financial reports with the Australian Securities and Investments Commission (ASIC). The question does not have a singular answer.

In the first instance the Corporations Act 2001 (the Act) deals with applications for relief from preparing and lodging annual financial reports and directors’ reports and having the reports audited.

In the second instance there is an ASIC class order which enables companies not to have their annual financial reports audited.

Both apply to large proprietary companies.

Most of the information in this article is taken directly from ASIC policy statements and class orders. For further explanatory material see ASIC policy statements 43 and 115.

This article has two parts. Part one deals with applications for relief from preparing and lodging annual financial reports and directors’ reports and having the reports audited. Part two deals with explanation of a class order which enables companies not to have their annual financial reports audited.

Section 45A(3) of the Act defines a large proprietary company (LPC) as: “A proprietary company is a large proprietary company for a financial year if it satisfies at least two of the following paragraphs:

(a)  the consolidated gross operating revenue for the financial year of the company and the entities it controls (if any) is $10 million or more;

(b)  the value of the consolidated gross assets at the end of the financial year of the company and the entities it controls (if any) is $5 million or more;

(c)  the company and the entities it controls (if any) have 50 or more employees at the end of the financial year”.

This definition now catches many companies which were always thought of as “mum and dad” companies. As such, inquiries about compliance are on the increase. However, it seems that many “mums and dads” and their advisers overlook the required compliance completely.

Part 1

Relief from preparing financial reports and directors’ reports and having reports audited
The Act requires LPCs to:

  1. prepare annual financial reports and directors’ reports; and
  2. have the financial reports audited and obtain an auditor’s report.

Subject to Part 2, relief from (1) and (2) appears to be a rarity and is governed by ASIC policy statement 43 entitled “Accounts and audit relief”.

Relief is considered on application by the directors stating the legislative provision for which relief is required and the reasons for seeking it.

Before ASIC can make an order under s340 it must be satisfied that at least one of the preconditions in s342(1) has been met.

To make an order under ss340 or 341, ASIC must be satisfied that complying with the relevant requirements would:

(a)  make the financial report or other reports misleading; or

(b)  be inappropriate in the circumstances; or

(c)  impose unreasonable burdens.

Section 342(2) In deciding for the purposes of sub-s(1) whether the audit requirements for a company would impose an unreasonable burden ASIC is to have regard to:

(a)  the expected costs of complying with the audit requirements; and

(b)  the expected benefits of having the company comply with the audit requirements; and

(c)  any practical difficulties that the company faces in complying effectively with the audit requirements (in particular, any difficulties that arise because a financial year is the first one for which the audit requirements apply or because the company is likely to move frequently between small and LPC from one financial year to another); and

(d)  any unusual aspects of the operation of the company during the financial year concerned; and

(e)  any other matters that ASIC considers relevant.

Section 342(3) In assessing expected benefits under sub-s(2), ASIC is to take account of:

(a)  the number of creditors and potential creditors; and

(b)  the position of creditors and potential creditors (in particular, their ability to independently obtain financial information about the company); and

(c)  the nature and extent of the liabilities of the company.

As can be seen, sub-ss342(2) and (3) above drill down into sub-s342(1)(c) above. There is no such drilling down into sub-ss342(1)(a) and (b) above. However, the following is taken from policy statement 43 on s342(1)(a):

“[PS 43.16] A requirement of the law may be misleading where compliance with that requirement would probably result in a reader of the accounts or directors’ report forming an incorrect conclusion concerning a feature of the company, or where compliance would result in the distortion of a particular piece of information required by the law.

“[PS 43.17] However, before relief is granted on the strength of this ground, it must be established that the difficulty could not reasonably be remedied by the directors through the inclusion of appropriate additional information and explanations, as required by s299(1): QBE v ASC (1992) 8 ACSR 631. ASIC envisages that the relief based on this pre-condition will be only granted in rare circumstances.

“[PS 43.18] Proof that the required disclosure is uninformative or irrelevant is, in itself, insufficient to establish that the accounts or report would be misleading”.

And as to s342(1)(b):

“[PS 43.19] The ‘inappropriate to the circumstances’ pre-condition will normally only apply in cases where there is an anomaly in the law or in cases where compliance with the law will give rise to consequences not intended by the legislature: Mazda v ASC (1992) 8 ACSR 613. For example, a requirement of the law may be considered inappropriate to the circumstances ... where compliance with that requirement would be inconsistent with the procedure adopted ... in accordance with another Australian legislative requirement ...

“[PS 43.20] It is not sufficient for an applicant to show that the requirement is irrelevant or of no benefit to users of the accounts or report. For example, the fact that shareholders of a subsidiary company already have access to the information required to be disclosed, through their board of directors, is not a relevant factor in determining the application if the shareholders of the ultimate holding company do not also have access to the information”.

A lot more has been written about sub-s342(1)(c) as it seems to be the sub-section most appropriate to hang the company hat on.

“[PS 43.23] A requirement of the law may be burden some in one of two ways:

(a)  there may be a burden associated with attaining compliance with the requirement; or

(b)  a burden may result from having complied with the requirement.

“[PS 43.24] However, before relief can be granted, the applicant must demonstrate not only that there is a burden, but also that the burden is unreasonable. In Mazda, the Oxford English Dictionary definition of ‘unreasonable’ was invoked to conclude that an unreasonable burden, in the context of the law, is a burden that goes beyond what is based on reason or good sense, goes beyond what is equitable or is excessive ...

“[PS 43.25] In relation to sub-para 23(a) above ... the fact that compliance will involve additional costs or that the compilation and analysis of the required information will present difficulties and necessitate ... to obtain the assistance of an expert does not, in itself, satisfy the unreasonable burden pre-condition ... applicant must demonstrate that the administrative burden is out of all proportion to the value of the resultant disclosures to the users of the accounts. Similarly, under sub-para 23(b) above, an application will only be successful if the burden is such that a serious economic detriment will result if there is compliance with the legislative requirement with little or no compensating benefit to users of the accounts: Liquid Air (1989) 15 ACLR 29”.

Competitive disadvantage argument
Paragraph 27 of the policy reads:

“... For such an argument to succeed, the applicant would need to demonstrate that if the disclosure requirement is complied with competitors, suppliers or customers will be able to estimate the profitability and/or contribution margin per unit of output and that this information can then be used to gain an advantage over the applicant company, giving rise to detrimental economic consequences ...”.

On the point of competitive disadvantage, Incat ((1999) AATA 800) examined the recent cases as follows. The case related to an application for relief from lodging annual accounts.

From paras 17-20 (incl):

“17. Two cases which considered the question of unreasonable burden were Liquid Air v Commissioner for Corporate Affairs (1989) 15 ACLR 29 and Mazda v Australian Securities Commission (1992) 8 ACSR 613. Both were concerned with relief from compliance with certain requirements of accounting standards and not as in the present matter with relief from the lodging of accounts. In Liquid Air, Master Staples applied a balancing test, the economic detriment likely to be caused to the company against the value of information to the users of the information, in deciding whether relief should be granted from compliance with the applicable accounting standards under the then Companies (WA) Code to disclose sales revenue and operating profit in the company’s accounts. In that case the Commissioner of Corporate Affairs did not challenge the proposition that disclosure of the information would place Liquid Air at a competitive disadvantage to its competitor which was not required to make the same disclosure in relation to its WA operations but only in total for the whole of its Australian operations. In balancing the factors referred to, Master Staples found in favour of Liquid Air.

“18. The Tribunal in Mazda did not follow this approach at 625:

‘ ... the task is not simply finding the balance of convenience. The use of the word “unreasonable” indicates that the balance must be so far against the interests of the applicants as to be fairly described as overwhelming’.

“20. In the present context, a judgment has to be made as to whether the burden or obligation to lodge accounts is ‘unreasonable’ in the ordinary meaning of the word, that is ‘exceeding the bounds of reason; immoderate; exorbitant’ (Macquarie Dictionary 3rd edn) as distinct from something that is moderate or not excessive, that is, reasonable. Insofar as the Tribunal in Mazda found that ‘unreasonable’ equates with ‘overwhelming’, I would respectfully disagree if it be thought that the burden must be regarded as ‘crushing’, one meaning of the word ‘overwhelming’. The difference is one of degree rather than substance but it seems to me in the present context that while a burden that is overwhelming is an unreasonable one the converse is not necessarily true. Whether a burden may fairly be described as ‘unreasonable’ is essentially one of fact requiring an evaluation of the evidence, having regard to the nature of the requirement to be performed, keeping in mind the policy objective of the legislation that companies of economic significance lodge accounts and the extent of economic detriment (if any) likely to flow to the applicants as a result of compliance”.

In Incat, Deputy President BM Forrest held that precise calculation of profit per vessel manufactured could not be adduced by customers from information contained in the financial statements, to the detriment of Incat.

He went on to say that to make an order on the basis of unreasonable burden, due to the disclosure to customers of a high return on investment, appears to be somewhat different to granting relief because a customer may extract precise information from financial statements of a specific nature (profit per unit sold), which may be detrimental to future earnings and/or competitiveness. Granting relief to a company solely due to the disclosure of high return on investment results may allow the segmentation of a business to avoid disclosure of high profit, a potential consequence which cannot be in harmony with the object and purpose of the legislation.

Part 2

Audit relief
“When a proprietary company meets the requirements of class order 98/1417, it does not have to apply ... for individual relief ...

“Relief ... is given ... to proprietary companies that have not had their financial report audited for any financial year ending during 1993 or since”.

ASIC will generally only give audit relief to a proprietary company under this policy statement if the following requirements are met:

(a)  directors and shareholders of the company agree that an audit is not required;

(b)  ASIC is satisfied that the company applying for audit relief is well managed and in a sound financial condition, in respects most directly relevant to the interests of creditors;

(c)  the company’s year end financial report is compiled by a “prescribed accountant”; and

(d)  the company lodges its financial report within the deadlines in the Act.

Unanimous resolutions
Relief will be given only when directors and shareholders (whether holding voting or non-voting shares) unanimously resolve that the company’s financial report should not be audited for each financial year to which the relief applies. These resolutions must be made within the period commencing three months before the start of the financial year and ending one month after the start of the financial year, or within such other time as approved in writing by an officer of ASIC.

In the notice of meeting the directors must state whether, in their opinion, the expected costs of having the financial statements of the company audited outweigh the expected benefits of the audit. The reasons for the directors’ opinion must also be included.

A notice that the company is relying on the audit relief must be lodged with ASIC. This notice must be lodged within the period commencing three months before the start of the financial year and ending one month after the start of the financial year.

Lodgment of a form 382 for ASIC’s public database and the processing of that form onto the database does not indicate that ASIC has given any form of approval and does not alone enable a company to take advantage of audit relief under the class order. A company will only have the benefit of relief if it meets all of the requirements of the class order. Where the form is late, a company will only have the benefit of relief if it is specifically granted an extension of time by ASIC in accordance with the class order.

Audit relief will only be available to those proprietary companies which are well managed and in a sound financial condition in respects most directly relevant to the interests of creditors. These requirements are discussed in the following paragraphs.

Directors must have appropriate internal management systems and procedures which allow them to assess the financial condition and the solvency of the company. The nature of these systems and the frequency of these procedures must be adequate for this purpose and appropriate to the company’s business and financial circumstances. As a minimum, however, the assessment by directors must include a quarterly assessment of a profit and loss statement, balance sheet and cash flow statement of the company prepared for management purposes.

The directors must resolve within one month after the end of the relevant quarter that the company has met the criterion to determine if the company is in a sound financial condition:

(a) at the end of that quarter; and

(b) at the time the resolution is made.

A company is in a sound financial condition if it has all the following characteristics:

(a) its total liabilities do not exceed 70 per cent of its total assets, excluding intangible assets;

(b) intangible assets are excluded in the above ratio; and

(c) it makes an operating profit after abnormal items and tax for either the relevant financial year or the immediately preceding financial year.

Directors must make an unqualified solvency statement in the directors’ declaration.

The year-end financial report must be compiled by a prescribed accountant and be in accordance with the Miscellaneous Professional Statement, “APS 9”.

Relief is only available if a company lodges its financial report and directors’ report for the relevant financial year and the immediately preceding financial year within the deadlines in the Act.

If the company takes advantage of audit relief, its directors must state in the directors’ report for the relevant financial year that they have:

(a) relied on audit relief given by ASIC; and

(b) complied with all the requirements of this relief.

GERARD KENNEDY is a partner with Macpherson & Kelley. He is an accredited business law specialist and member of the LIV Business Law Advisory Committee, the LIV’s Commercial Law Section and Law Council of Australia (international trade).

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