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Private vs public companies
Writers have consistently asked us to analyse financial statements of companies which are not public companies. Companies that do have their shares being publicly held or which we consider to be ‘public interest companies’ are considered proper for review in this column, but on professional grounds an accountant would be precluded from undertaking a review of the companies of which he is the auditor.
Business Page believes that the public interest will be much better served if others take the challenge to critically analyse companies and bring their voices to the debate. They should be willing to challenge the companies for information and to bring issues to the public. In that way, we can become not only better informed but more civilised.
We now turn our attention to the statutory provisions relating to directors’ remuneration/emoluments and the legal opinion on which the Institute of Chartered Accountants of Guyana has been relying.
Incidentally, the provisions of the Companies Act on directors’ remuneration and emoluments and the provisions in International Accounting Standards apply to both public and private companies equally. There is one distinction, however: the Companies Act allows a private company to delete disclosure of directors’ emoluments pursuant to section 163 (see below) to be deleted from the annual return which when filed at the registrar’s office becomes public information. This is to protect the confidentiality of the information with respect to private companies.
The Companies Act
The Companies Act, 1991 was brought into force in 1995. On November 18, 1997 the Institute of Chartered Accountants of Guyana (ICAG) received legal opinion on the “level of approval and disclosure relative to Directors’ emoluments pursuant to Sections 104 and 163 of the Companies Act, 1991” which can be summarised as follows:
Section 104 (1) is intended to cover remuneration paid to a director for his services as a director and not his services as a manager.
In interpreting Section 163 one should distinguish between contract of service (normal employment) and contracts for services (independent contractors such as consultants or other professional advisors). In the lawyer’s opinion, section 163 only refers to directors’ contracts for services, and does not relate to a contract of service between a company and its manager.
The lawyer recommended that hybrid terms such as ‘Managing Director’ not be used, and that any provisions in the company’s articles creating such hybrid posts be amended. He also recommended that the company’s articles provide that senior officials may serve as directors but be separately remunerated.
While Ram & McRae has consistently disagreed with the thrust of this opinion, and more particularly for its ignoring of the relevant Accounting Standard, the ICAG has conveyed to the members of the profession copies of the advice without reservations, or recommendations that the advice should be considered in full.
As a result, hybrid positions such as Chairman and Chief Executive Officer, and Executive Chairman and Managing Director, although not consistent with the recommendation of the legal counsel, still exist. Until the ICAG has reviewed its position, companies are free to rely on the legal opinion.
We have, however, discussed with and convinced a lot of our clients that the disclosures are appropriate (under the Companies Act and under IAS 24) although some of them argue that if they were to disclose information which their competitors were insisting as not required, they would be competitively disadvantaged.
In reviewing the legal opinion currently relied upon by the ICAG, Ram & Mc Rae makes the following observations:
1. They agree that Section 104 of the Companies Act, 1991 relates to services as a director and not a manager. In fact, section 104 (5) defines ‘remuneration’ as “... relating to services as a director of a company or any of its subsidiaries.”
2. Section 104 should be distinguished however from Section 163 in that the first refers to directors’ remuneration while the latter refers to directors’ emoluments - two terms that are defined quite differently. Section 104 deals with the payment and approval of remuneration while section 163 deals with the disclosure of emoluments.
3. Paragraph 2a of section 163 states that emoluments shall include amounts “... paid to, or receivable by, a person in respect of his services as a director... or otherwise in connection with the management of the affairs of the company...”
4. Paragraph 2b of section 163 further states that the disclosure of emoluments in the annual accounts of a company “shall distinguish between emoluments in respect of services as a director, whether of the company or of a company affiliated with the same group of companies as the company, and other emoluments.” It is my view, and this is supported by one leading accountant who was involved with drafting the Companies Act, that “other emoluments” refer to any payments in whatever capacity. I have brought this to the attention to the Institute but no attempt has been made so far to consult with this member.
5. The definition included in section 163 for emoluments does not contain the same limitation sentence as section 104 i.e. does not say “relating to services as a director.”
6. The Companies Act allows private companies under paragraph 154 (3) to exclude from its annual return information pursuant to section 163. I believe that this is a recognition of the greater responsibility which public companies have in matters of disclosure.
Incidentally, many of our companies (public and private) still carry hybrid posts such as ‘managing director’ and ‘executive chairman’ suggesting that the legal advice is only selectively being applied.
The related party problem Part 2
Last week we began addressing the related party problem with an in- depth look at the disclosure requirements for directors’ emoluments in the Companies Act. Readers will recall the view of this column that the related party issue has to be addressed, even from the perspective of the generalist, from two perspectives - the Companies Act 1991 and relevant accounting standards. Of course there is legislation specific to the insurance and financial industries while stock exchanges may prescribe additional rules for public companies. Today’s contribution to the discussion examines the provisions in International Accounting Standard #24 - Related Party Disclosures.
“Perhaps there is no single IAS which has generated as much controversy as IAS 24.” This is how I started my presentation at the Institute of Chartered Accountants of Guyana (ICAG) seminar on Related Parties held at the Hotel Tower earlier this year. I have previously commented on the reluctance of directors to disclose their emoluments. You might ask why?
Could you imagine reading in a company’s financial statements that the emoluments paid to this elite group of people exceeded that paid to all other staff? Could you imagine that the same entities which are telling its shareholders that business is bad are paying their executive directors increasing salaries and benefits?
Whatever the reason, it’s reality; directors who are paid substantial amounts do not want the public and more importantly their shareholders to know how much they pay themselves. Indeed, I have come across an entity which bought a controlling share of another entity from some directors for in excess of $44 million without disclosing that fact. This is not a salary but many might have questioned the real worth of the business.
While IAS 24 is a relatively old standard - approved by the International Accounting Standards Committee in March 1984 - the problem of non-compliance is still prevalent not only in Guyana but worldwide. The publication UK & International GAAP plus by Ernst and Young (with which Ram & McRae is affiliated) stated “it is fair to say that many accounts purporting to comply with IASs do not give any disclosures about emoluments of, or transactions with, key management personnel.”
The standard is relatively small with only 26 paragraphs - not enough to adequately address the problem it seems. In addressing the disclosure of management compensation, the relevant paragraphs are 3 (d) and 20 to 23, each of which will be examined in turn.
Paragraph 3 of the standard specified the type of related party relationships that it deals with. Paragraph 3 (d) stated: “key management personnel, that is, those persons having authority and responsibility for planning, directing and controlling the activities of the reporting enterprise, including directors and officers of companies and close members of the families of such individuals.”
Let’s point out a few characteristics of the above paragraph - 1) it listed key management personnel as the related party relationship. This means that it was not limited to the directors; 2) it specifically included directors and officers. This ensures that the definition is not taken out of context by directors who may not want to consider the definition to include them; and 3) it includes close members of the families of such individuals. The Standard recognises that some directors may make payments to their family members and claim that the payments were not received by them.
There has been no debate as to whether the IAS addresses executive directors. The debate has centered on what type of transactions should be disclosed. Many companies locally have used the legal opinion received by the ICAG on the Companies Act to say that disclosure is not required, full stop! This completely ignores the fact that the Standard is 1) required to be complied with under the same Act; 2) is a stand alone document; and 3) may contain more stringent provisions that the Act.
To further prove that directors are related parties, we can refer to the Standard’s definitions of control and significant influence. Under these definitions the Board of Directors as a whole controls the enterprise i.e. they have the power to direct the financial and operating policies of the management of the enterprise. Each director will have an influence on the Board’s policies. Indeed it is normal for an individual director to propose the policy which is reviewed and adopted by the Board.
IAS 24 defines a related party transaction as “a transfer of resources or obligations between related parties, regardless of whether a price is charged.” In the case of emoluments of executive directors, the emolument itself (cash or otherwise) is considered the resource that is being transferred to the individual persons.
Paragraph 19 gave examples of situations where related party transactions may lead to disclosures. The very last example was “management contracts.” Some might argue that this only relates to the types of management contracts in place in the state-owned enterprises such as Guyana Power and Light, Inc, GUYSUCO and most recently Guyana Water Inc.
These are significant contracts and make a significant impact on the financial performance of the entity. This article is not about the relative values the entities received - that is for the public to judge based on the performance of the entity in given economic circumstances.
If one therefore agrees that such management contracts require disclosure, what about the contracts of individual managers which eventually may have the same effect on the entity’s performance?
Paragraph 20 states that “related party relationships where control exists should be disclosed irrespective of whether there have been transactions between the related parties.” The Standard notes that in order for the reader to form a view about the effects of related party relationships, it is appropriate to disclose the related party relationship where control exists. The existence of transactions does not matter. For example, if a director of one company owns another company, then it is likely that decisions may be made in the first company that indirectly benefits the second company.
Paragraph 22 states that “if there have been transactions between related parties, the reporting enterprise should disclose the nature of the related party relationships as well as the types of transactions and the elements of the transactions necessary for an understanding of the financial statements.”
The Standard further stated that the elements of transactions necessary for an understanding of the financial statements would normally include:
(a) an indication of the volume of the transactions, either as an amount or as an appropriate proportion;
(b) amounts or appropriate proportions of outstanding items; and
(c) pricing policies.
These last two paragraphs simply state that where there has been transactions (emoluments) between related parties (the entity and its directors, executive or otherwise), disclosure is needed!
Some commentators have suggested that recent proposals of the International Accounting Standards Board (IASB) to exclude and then later to include specific provisions on disclosures meant that the existing Standard does not require such disclosures. Is it not obvious that an exposure draft is only a proposal. The initial exposure draft proposed an exclusion paragraph to the existing standard, the existing standard clearly requires the disclosure.
The IASB proposed last year to amend IAS 24 to specifically exclude disclosure of management compensation as Canada did a few years ago. The IASB asked in its exposure draft “Do you agree that the Standard should not require disclosure of management compensation, expense allowances and similar items paid in the ordinary course of an entity’s operations?”
A response from the Accounting Standard Board of the United Kingdom stated that “the Board believes that the structure and amount of management compensation can be a major driver to business strategy and that it is of prime concern to shareholders. There should, therefore, be disclosure for the same reasons as set out in paragraphs 5 to 8 (the purpose of related party disclosures) of the proposed standard.”
Many other responses from worldwide standard setters felt the same way. Consequently the IASB was put in a position to reconsider its proposal and in February of this year announced that it was reexamining the issue.
Incidentally, the IASB in trying to justify its original proposal stated that it was preferable for national standard setters to require disclosure of management compensation than for IAS 24 to require these disclosures. National standard setters in the context of Guyana would be the ICAG, which has decided to adopt IAS’s without modification. Such disclosures may also be required in law - the Companies Act or the Securities Industry Act, for example.
The UK’s Accounting Standards Board noted that not all jurisdictions have separate disclosure requirements in this area and therefore IAS 24 should set a minimum disclosure level so that the objective contained in paragraph 6 of the Preface to IAS’s is met.
Last week we stated why we believed that the Companies Act required the disclosure of directors’ emoluments. This week, we gave our justification under IAS 24. We now leave it up to readers to decide whether the analysis is complete and correct.