The UK Government has launched an important consultation on proposals to reform audit – responding to recommendations from three key reviews, including the Brydon review, in which we participated on an Advisory Board.
The BEIS consultation on “Restoring trust in audit and corporate governance” comes at a critical time, as the UK re-emerges from an economic downturn of unprecedented scale. Businesses need to rebuild, and equity must be sensibly allocated. Perhaps more than ever, the public depends on reliable accounts to underpin resilient businesses.
We have long spoken out about the importance of removing conflicts of interest that undermine auditor independence and ensuring the capital maintenance regime is robust. It is good to see that the proposals put forward in the BEIS consultation demonstrate a willingness to act to address insidious weaknesses in the accounting and audit infrastructure. This infrastructure is crucial in underpinning a prosperous and sustainable economy. Alongside the importance of independent and high-quality audit, they make clear the importance of director duties to protect capital – and not to pay dividends if that puts a company at risk, thereby endangering all its stakeholders.
What is startling in the BEIS proposals, however, is what it tells us about weaknesses in our capital maintenance regime today. BEIS states that where directors “don’t know” what their distributable reserves are, they should declare what is known, and limit dividends to less than this number. While this clearly is prudent, and we are supportive of the guidance, why do they not know?
Likewise, for companies that combine several subsidiaries into a Group, BEIS indicates that directors should “estimate” this number.
Ignorance of any company’s distributable reserves flies in the face of Part 23 of the Companies Act 2006, which requires that the published audited accounts should include the number for “undistributable reserves”. In other words, this number should be known, not estimated. It should also be audited.
Knowing what capital companies have accumulated that they can safely distribute should not be a matter of guesswork. If this is the case today as implied by BEIS, then that could help us understand what went wrong at Carillion, Thomas Cook and many other recent company failures. Sarasin & Partners and other investors have been raising the alarm over precisely this problem for many years. The BEIS Select Committee also underlined the centrality of capital protection in their report in 2019 on the future of audit. It should be taken up now as an urgent matter of enforcement, not buried deep in a 230-page consultation.