New extracts from the ESMA database of IFRS decisions
In May 2022, the European Securities and Markets Authority (ESMA) published further extracts from its confidential database of enforcement decisions taken by European national enforcers.
In the following article, we have summarised what needs to be done in connection with the approval of financial statements, how to time the necessary steps leading to their disclosure, why it is advisable not to forget to appoint an auditor and what pitfalls may lurk when paying out profit shares. We will focus mainly on business companies and cooperatives.
Financial statements approval
Financial statements are a set of financial reports that an entity prepares for a reporting period as at the balance sheet date. According to Section 18(1) of Act No. 563/1991 Coll., on Accounting (the Accounting Act), financial statements consist of a balance sheet, profit and loss account and notes that explain and supplement the information contained in the balance sheet and in the profit and loss account. In some cases, an entity is obliged to also include a cash flow statement and a statement of changes in equity in the financial statements in accordance with Section 18(2) of the Accounting Act.
According to Act No. 90/2012 Coll., on Business Corporations (the Business Corporations Act), the General Meeting must discuss the company’s regular financial statements no later than six months after the last day of the previous reporting period – i.e., until 30 June of the following year (except for companies whose reporting period ends during the fiscal year). The decision of the General Meeting also includes the settlement of profit/loss.
Ways of profit/loss distribution, payment of profit shares
The General Meeting decides on the distribution of profit and the statutory body decides on its payment. However, according to the recent decision of the Supreme Court 27 Cdo 3330/2020, the General Meeting can also decide on the payment of profits on a one-off basis, but only if such a decision is taken by a qualified majority of votes (i.e., 2/3 of those present) and certified by a notarial deed. In view of the increased costs associated with, inter alia, the involvement of a notary and the required number of votes, the decision of the General Meeting in this matter is not very practical. Therefore, if the shareholders want to achieve the payment of an advance on the profit share, they may, by a simple majority of votes, instruct the statutory body to decide on such a payment.
Now let us proceed to the actual ways of distributing the profit or loss: the profit can be distributed to the owners – if an advance on the dividend has been paid, it is necessary to settle this advance. A specific situation may arise in the event that a change in the owner takes place in the period between the payment of the dividend advance and the payment of the final dividend. The question arises as to what to do with the dividend advance. ‘An advance on the payment of a share in profits shall be settled against the owner or member who holds the share for which the advance payment has been paid on the due date of the profit share.’ (see Opinion No. 30 of the Commission of the Ministry of Justice for the Application of New Civil Legislation of 25 June 2014). The opinion that the right to settle the advance on the profit share passes together with the share for which the advance has been paid is held by the majority of respected authors. The advance paid is therefore not returned to the new owner as a standard.
A problem may also arise if the profit share is paid in a foreign currency. In such a situation, the share in profit expressed in foreign currency will be valued by conversion into Czech crowns using the exchange rate at the date of the General Meeting’s decision and we will also account for a payable to owners. The settlement of the payable expressed in foreign currency occurs only on the date of payment; until then, exchange rate differences may arise in respect of the payable, but these are, of course, no longer reflected in equity.
Other options for profit distribution are transfers to the account of accumulated profits brought forward. The profit can be used to cover losses from previous years (if a loss is reported); it is also possible to decide on the allocation to the funds that the company has established.
The loss can then be covered from accumulated profits brought forward (if available) or transferred to the account of accumulated losses brought forward.
The amended version of the Business Corporations Act effective from 1 January 2021 took over the already existing case law and confirmed that profit shares can be paid on the basis of regular or irregular financial statements approved by their supreme body until the end of the following reporting period. It is therefore certain that there is no need to prepare extraordinary financial statements, even if the decision on the distribution of profit and other own resources is made after 6 months have passed from the balance sheet date (as many companies feared due to the previous amendment to the Commercial Code). Protection for shareholders, creditors or other stakeholders against excessive disbursement of resources is provided by tests that are now included in Sections 34, 35 and Section 40 of the Business Corporations Act. We have covered this topic in detail in this article.
Appointment of the auditor
In the case of companies subject to a statutory audit, it is also appropriate to add an item relating to the appointment of an auditor to the agenda of the General Meeting. The obligation to have financial statements audited is imposed by Section 20 of the Business Corporations Act. It is based primarily on the categorisation of reporting entities as well as value criteria. These criteria for a statutory audit deal with the total assets as per the balance sheet, the annual total net turnover, and the average number of employees, using the methodology of the Czech Statistical Office. The value criteria are identified in the category of small entities. The obligation to have the financial statements audited arises when those criteria are met or are already exceeded. The statutory audit of financial statements is carried out for the first time for the second reporting period in which these criteria were exceeded (for joint-stock companies, exceeding one criterion is sufficient; for other entities, two out of three).
The obligation to appoint an auditor by the supreme body of the company is laid down by Act No. 93/2009 Coll., on Auditors (the Auditors’ Act) and applies to statutory audits. An auditor may be appointed for more than one period. If the contract with the auditor is signed before the appointment by the supreme body of the company, which is required by the provision of Section 17(1) of the Auditors’ Act, this is not a statutory audit contract, but a non-statutory audit one. It is therefore necessary to conclude a new statutory audit contract. Similarly, in the case where the appointment of an auditor is completely absent, it is again not a statutory audit, but a voluntary one.
Publication of financial statements in the Collection of Deeds
The methods of the disclosure of approved financial statements are set out in Section 21a of the Accounting Act. If the companies meet the legal criteria specified in Section 20(1) of the Accounting Act, they must have their financial statements audited.
Entities prepare financial statements in full or in abridged form. Unless the Accounting Act provides otherwise, abridged financial statements may be prepared by entities that are not subject to a statutory audit of their financial statements. If it is relevant for the company, in addition to the financial statements, it also prepares a report on related party transactions. Audited entities disclose their financial statements as part of an annual report, which also includes a report on related party transactions (if the company prepares one) and an auditor’s report, or other documents or data (for example, a report on payments to the administration authorities of an EU member state or a third country). They should do so within 30 days of verification by the auditor and approval by the competent authority (General Meeting or sole owner).
The filing of financial statements in the Collection of Deeds, regardless of the audit obligation, must be carried out no later than the end of the immediately following reporting period – at least to the extent stipulated for the given category of the reporting entity.
Business corporations may now publish their financial statements in the Collection of Deeds of the Commercial Register through the tax administrator. The obligation to disclose the financial statements is fulfilled at the moment of filing with the relevant income tax administrator. This makes communication between public administration systems more effective. Until now, two acts have been necessary (filing an income tax return with the tax administrator and sending the financial statements to the registration court); those are now replaced by one filing. However, compliance with the disclosure obligation using this option is practically impossible for the audited company. According to Section 21b of the Accounting Act, the documents submitted may only be financial statements, not annual reports that are published by entities that are audited compulsorily. The new regulation thus targets mainly micro and small entities that are business corporations and that are not required to have their financial statements audited. We have covered this option in detail in last year’s article New publishing options for 2021 financial statements. In April this year, the tax administration issued more detailed instructions for this procedure.