It was here; the envelope had finally arrived…

I knew it was coming. The past three years had been far too much fun. No worries about how I was going to fund that next drink, trip to the cinema (fifth time that month) or a visit to Cardiff’s finest curry house (Juboraj - next to Roath Park). Just reckless abandonment with my debit card.

But here it was. 

I slowly opened the letter, scanned past the fancy letterhead and started to read…

‘Cancellation of your student overdraft…from now on any unauthorised overdrafts will incur a penalty fee and daily interest charges.’ 

The days of not being aware of what I was spending were over.

If you are anything like me, at this stage you would have started a budget and monitored what you were spending to make sure that (as far as possible) you never needed to go into your overdraft again.

Unfortunately, a lot of companies aren’t thinking about whether they are close to their ‘overdraft’ when making a distribution. A quick glance at last year’s reserves, a signature by the board and off the dividends go.

This lack of consideration has become so concerning that from 1 January 2019, the FRC is now expecting large companies to include disclosure of how the Directors have assessed their fiduciary duties around distributions in line with the s172 of the Companies Act 2006 (“CA06”). 

It's not just large companies that should take note. Under the CA06, all Directors need to follow the guidance of s172 and be satisfied that they have policies and procedures to ensure their dividend policy stands up to scrutiny.

Are you missing out these final two steps in your distribution process?

Helpfully, the ICAEW and ICAS have produced some guidance on how to deal with realised and distributable profits under the CA06 [Tech 02/17]. Unfortunately, it’s 173 pages and can take ages to get your head around.

Having helped lots of companies navigate this guidance, most Directors in our view miss two final key steps:

1)    Consideration of transactions that present significant profit volatility

When looking at distributable reserves, it can be easy to miss that prior to signing off the accounts, that positive number could be quickly wiped out by accounting profit volatility in the next period. Although the movements may be considered realised under the CA06 and therefore available for distribution, the Directors should assess whether a distribution would be prudent, taking into account next year’s potential movement.  

Fair value accounting movements can be quite easy to spot. In fact, the guidance includes reference to fair value accounting movements on financial instruments as a specific area of consideration when determining a distribution [Tech 02/17 – para 2.4 - 2.5]. 

But what about foreign currency movements? A foreign currency credit to reserves will normally meet the definition of a distributable reserve. However, if the monetary asset on which the foreign currency credit was recognised reduces in value, there could be a reduction in that credit. If this is not picked up prior to a distribution being made, that distribution may become illegal.

If you have recognised these types of foreign currency credits in your profit and loss, you may need to spend a bit of extra time deciding whether to restrict the distribution of some or all of these gains until they become crystallised. 

2)    Consideration of whether there are any changes to accounting standards or other events that are not yet recorded in the accounts

It’s often forgotten that the accounts of a company reflect a single point in time and were prepared with the information available to management at year end. When declaring a distribution however, any future changes that provide an update on values in existence at the balance sheet date may need to be reflected in the accounts. If any update results in a reduction in reserves, any distributions made prior to this change may be exceeding available reserves.

For example, with Brexit still rumbling along, there are potentially a number of areas of the balance sheet that could be impacted (I promise, no more on Brexit – you can go on a tour of the Brexit balance sheet here).

Further, if you are applying IFRS 16 “Leases” for the first time and haven’t yet published your accounts, we have seen reserves reduce on transition. Determining the impact on transition to a new accounting standard should be a key step in both your conversion and during any distribution sign-off process.

Finally, the Directors should look ahead to see whether any events have occurred after the last relevant accounts, that would erode any of the current realised profits. A good example here would be the loss of a key customer contract or supplier.

Are you straying close to your overdraft?

Luckily, I was able to make sure that I didn’t stray back into my overdraft (that often). It required me to look not just at the balance that was there, but also to think about my future spending.

If you are looking at making any distributions, factoring the above two steps into your process should help reduce some of the risk of you making an illegal distribution.

And don’t forget you will need to document any considerations and processes that you have put in place. 

If you would like to discuss the above or any other questions relating to financial reporting, please do not hesitate to get in touch. My contact details are below. 

Jon Wallis

Financial Reporting Advisory Group

+44 (0)20 7728 2864

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