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Chapter 1 - Scope and purpose of the Inquiry
Background
1.1
The First Corporate Law Simplification Act
1995 (the Act), which amended the Corporations Law, changed the financial
reporting requirements for proprietary companies. The Act replaced the previous
distinction between exempt and non-exempt proprietary companies with a
distinction between large and small proprietary companies based on the
company’s assets, revenue and employees. In February 2000, the Parliamentary
Joint Statutory Committee on Corporations and Securities (PJSC) resolved to
inquire into the new reporting system.
1.2
The PJSC undertook this inquiry for two reasons.
When the new reporting requirements were introduced, the object of the policy
was to reduce the reporting obligations of small proprietary companies.
Conversely, reporting standards for large proprietary companies which have
significant economic impact were strengthened. These companies would be
required to prepare accounts, have them audited and lodged with the Australian
Securities and Investments Commission (ASIC). The Act also established criteria
for granting exemptions if the reporting requirements imposed unreasonable
burdens on the companies. In two previous reports in 1995, the PJSC had noted
that the large/small distinction might impose significant audit costs. This
initial view was strengthened by early and significant indications of problems
with the new reporting system. These emerged at the time the PJSC reviewed the
Draft Second Corporate Law Simplification Bill 1996 and again, in the context
of the PJSC’s examination of the 1995-96 ASIC Annual Report. The PJSC decided
to defer a review of the large/small test for proprietary companies until the
ASIC was able to collect more reliable information on the number and size of companies
affected by the change.[1]
1.3
The Treasurer had also foreshadowed a review of
the large/small test two years after its commencement “to ensure that its
practical operation does not place an undue burden on business.”[2] The PJSC considered that the
proposed review by the Treasury would be limited in scope and would not address
all the problems with the new reporting system. It was important that any
review should assess the effectiveness of the large/small test and consider
additional measures to enhance the accountability of proprietary companies. An
important development in this regard has been the extension of the duties of
directors as a result of changes to the Law, such as the Corporations Law
Amendment (Employee Entitlements) Act 2000 and the Corporate Law
Economic Reform Program Act 1999.[3]
Common law developments have also created potential new duties of directors to
shareholders, creditors and employees of the company.[4]
Previous reports
Report on the First Corporate Law Simplification Bill 1994
1.4
In its March 1995 report, the PJSC was unable to
reach an unqualified view on the appropriateness of the large/small test and
the criteria used for distinguishing between large and small proprietary
companies. The test in the Bill provided that a proprietary company is small
only if it satisfied at least two of the following three criteria:
- assets less than $5 million;
- revenue less than $10 million;
- fewer than 50 employees.
1.5
Although an estimated 98 per cent of proprietary
companies would be classed as small and accordingly be exempt from the
reporting requirements, the PJSC concluded that the three-part test was to a
degree arbitrary. Concerns were raised that the two new categories of
proprietary companies may result in incorrect classification and inadequate protection
for creditors. In evidence to the PJSC, the accounting bodies proposed the
reporting entity concept as an alternative to the large/small test. The
benefits of the reporting entity concept were twofold: it was the more
meaningful test for determining reporting obligations and it was already in use
in other parts of the Corporations Law as well as the Accounting Standards.
1.6
However, the PJSC concluded, on balance, that it
preferred the large/small test over the reporting entity concept as a basis for
distinguishing between proprietary companies. It did so because, by comparison
with the three-part test in the Bill, the reporting entity concept “does not
provide a test of sufficient certainty to enable an objective assessment to be
made of whether a company falls within the entity test.”[5] The PJSC also took into account
the support for the new reporting system by the ASIC (formerly the Australian
Securities Commission) and the Law Council of Australia.
1.7
The PJSC then looked at the particular criteria
in the test. It considered that of the three criteria, the threshold tests of
assets and revenue were the most important and recommended that serious
consideration be given to two options:
- that the employees criterion remain; or
- that the employees test be deleted from the Bill
and the test for a large/small proprietary company be on the proposed assets
and turnover criteria alone.
1.8
The Government did not agree to amend the Bill.
It considered that the test in the Bill provided adequate flexibility. The
formulation of the test was designed to achieve an approximate measure of a
company’s economic significance and the proposal to reduce the criteria would
result in “a less appropriate test of a company’s economic significance, and
accordingly a less appropriate touchstone for the application of corporate
financial reporting requirements.”[6]
Report on Items 1-4, Schedule 4 of the First Corporate Law Simplification
Bill 1995
1.9
The PJSC repeated its concerns about the
potential impact of the large/small test on audit costs and the threshold
criteria used in the Bill in its report tabled on 30 August 1995. Estimates of
these costs ranged from $10,000 to $80,000 annually.
1.10
Four main approaches were suggested to overcome
this problem. One option was to amend the test so that fewer companies would be
classed as large proprietary companies. A second approach was to extend the
ASIC’s discretion to exempt companies from the requirement to have their
accounts audited. A third option was to alter the requirement thereby avoiding
the additional audit costs. Large proprietary companies would be able to rely
on their unaudited accounts provided that an external accountant prepared the
accounts. A fourth approach was to replace the large/small test with the
reporting entity concept.
1.11
The PJSC noted strong concerns that in some
cases the audit requirement was not justified.[7]
It considered that the problem could be addressed by expanding and clarifying
the ASIC’s discretion to exempt proprietary companies from the requirement.
Accordingly, the PJSC made a number of specific recommendations as to how the
ASIC should exercise that discretion:
Recommendation 1
The Bill be amended to provide that in exercising its
discretion under section 313 of the Corporations Law to exempt a large
proprietary company, or class of large proprietary companies, from the audit
requirement the Australian Securities Commission should have regard to, but not
be limited by, the following criteria:
the expected cost or burden of audit;
the expected public interest or benefit of making this
information available;
the number of creditors;
the nature and extent of a company’s liabilities;
whether it is the first year the company is required to
prepare audited accounts;
whether the company is one which
is likely to repeatedly move in and out of the large proprietary category over
a period of years.
Recommendation 2
The Committee recommends that the
exercise of the ASC’s discretionary power in the manner described in
Recommendation 1 be made subject to a process of public consultation and
scrutiny. The Committee also recommends that the ASC include in its Annual
Report details of how it has complied with its procedures.
Recommendation 3
The three tests contained in the
proposed section 45A, the criteria for exercising the ASC’s discretion, the
exercise of that discretion and the effectiveness and cost of the process be
reviewed by the government and this Committee after a period of two years.
Recommendation 4
In view of the delay in
commencement of the legislation, the Committee recommends that the Bill be
amended to defer the commencement of the audit obligation on large proprietary
companies until the 1996-97 financial year.[8]
1.12
The Government accepted all of the above
recommendations and the Bill was amended accordingly.[9] The Government also agreed that
ASIC Class Orders should be made following a transparent consultation process
and that the ASIC should include details of this in its annual reports.
‘Grandfathering’ of exempt proprietary companies
1.13
Under the previous distinction, exempt
proprietary companies were not required to lodge their accounts with the ASIC
if they appointed an auditor. The new reporting system would require some of
these companies to lodge audited accounts. The Bill proposed that existing
companies, which have their annual accounts audited and are large and which
continue to operate unchanged (‘grandfathered’ companies), would not be
required to lodge accounts with the ASIC.
1.14
The PJSC at first supported the proposal in its
March 1995 report. However, it reconsidered the matter in light of the evidence
presented during its reference on the Bill. In its report of 30 August 1995,
the PJSC referred to concerns that proposed sub-section 317B(3) would allow a
company already being audited, and falling within the large category, to be
exempted indefinitely from lodging accounts. A secondary effect of this
situation would be “the development of a trade in grandfathered companies.” The
PJSC recommended that:
Whilst not within
the Committee’s terms of reference, the Committee considers that the proposed
section 317B(3) (the ‘grandfathering’ clause) in the Bill be amended to include
a sunset period of three years from the date of commencement of the
legislation.
1.15
The Government did not agree to amend the Bill
to include a sunset period but recognised the need to review the grandfathering
provisions as part of the same review recommended by the PJSC.
Conduct of the inquiry
1.16
On 27 January 2000, the Minister for Financial
Services and Regulation, the Hon Joe Hockey MP, requested the PJSC to review
the test for determining whether a proprietary company is large or small and
the requirements for the audit and lodgement of financial statements by
proprietary companies. Subsequently the PJSC resolved to undertake a single
review, which would include a review of the large/small test foreshadowed by
the Treasurer.
1.17
In February 2000, the PJSC advertised for public
submissions and indicated that it would review the new reporting system with
particular reference to:
-
the three criteria comprising the large/small test;
- the appropriateness of having requirements for audit and the
lodgement of accounts for some classes of proprietary companies;
- the appropriateness of the criteria for the exercise of the
ASIC’s discretion;
- the manner in which the ASIC has exercised that discretion; and
- the effectiveness and costs of the process of providing
exemptions from the audit requirement.
1.18
The PJSC received 14 written submissions from
individuals, proprietary companies, accounting firms and professional organisations.
The PJSC held public hearings in Canberra on 28 June 2000 and Melbourne on 30
June 2000. Lists of published submissions and of witnesses who appeared at the
hearings are at Appendices 1 and 2.
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