Directors’ current accounts: Company law requirements

In the first of a two-part series on directors’ current accounts, Steve Collings considers the company law requirements. The second article examines the impact of FRS 102 on directors’ current accounts and the accounting issues that arise (click here to read).

Many companies have directors’ current accounts in operation and these can be a contentious issue in terms of financial reporting.

Directors’ advances, credit and guarantees are dealt with in the Companies Act 2006 (CA06) at section 413 Information about directors’ benefits: advances, credit and guarantees and it is important that practitioners and directors have a sound understanding of the requirements in order that correct accounting treatments and disclosure requirements are met.

Shareholder approval

Section 197(1) of CA06 makes a general prohibition on loans to directors and also related guarantees or provisions of security where the approval of the shareholders (often referred to as ‘members’) is not obtained.

However, such approval is not required for ‘minor’ loans, ie if the aggregate value of the transaction(s) does not exceed £10,000, hence companies are not prohibited under CA06 to make such loans.

If a company makes advances to a director personally and the aggregate exceeds £10,000 at any time, there is a legal requirement for the advance that takes the total over £10,000 to be approved by the shareholders BEFORE it takes place.

Most small companies will probably not know about this issue until someone tells them. However, failure to follow correct protocol could cause problems if there is a falling out between shareholders (for example in a husband-and-wife-run company where the husband and wife divorce) or if the company goes into liquidation.

In a lot of cases, the directors and the shareholders will be the same body of individuals but that does not mean that company law protocol does not have to be followed.

Advances to a director

When an advance to a director takes place, section 413 of CA06 requires the following details to be disclosed in the financial statements:

(a) its amount;

(b) an indication of the interest rate;

(c) its main conditions; and,

(d) any amounts repaid.

The notes to the financial statements must also disclose:

• the total amounts stated in (a); and
• the total amounts stated in (d).

Particulars are also required in respect of guarantees of any kind entered into by the company on behalf of the director(s), which disclose:

(a) the main terms;

(b) the amount of the maximum liability that may be incurred by the company (or its subsidiary); and

(c) any amount paid and any liability incurred by the company (or its subsidiary) for the purpose of fulfilling the guarantee (including any loss incurred by reason of enforcement of the guarantee).

In respect of advances to a director, confusion surrounded the requirements of section 413 when it was first introduced because the wording of this particular section indicates that every advance needs to be disclosed.

For companies where the directors’ current accounts are overdrawn, making disclosure of every individual entry would, in practice, be impractical and result in excessive information being disclosed.

Disclosures relating to advances to a director

All companies are required to prepare financial statements that give a true and fair view (although the financial statements of micro-entities prepared under FRS 105 are presumed to give a true and fair view).

In a lot of cases, advances to directors consist of several items which make up an overdrawn balance as at the year/period end. However, consider a company that simply makes a £50,000 advance to the director for the purpose of a house purchase. In this case, the disclosure could be as simple as:

‘During the period, the company made a short-term loan to a director amounting to £50,000 for the purposes of a house purchase. Interest at the rate of 4.5% per annum is payable half-yearly and the loan is repayable on 31 December 2020.’

Note: neither the CA06 nor FRS 102 require disclosure of the name of the director.

An issue that was raised when section 413 became mandatory was the disclosure of transactions where a director’s current account was made up of several items.

The wording of section 413 was subjected to a lot of criticism by accountants and various commentators and the professional bodies concluded that many companies would find it impractical to comply with the ‘letter of the law’ and hence came up with a solution whereby the accountant would determine the materiality of advances and repayments, aggregate the immaterial transactions and disclose separately material transactions, using the following ‘template’:

Where items of expenditure or repayment are considered to be material to the financial statements or are dissimilar in terms of those expenses which have been aggregated, these should be disclosed separately.

Care, however, should be taken where such a template for disclosing directors’ transactions are concerned. This is because it can be tricky to template disclosures as client circumstances vary so much and therefore the template is generally persuasive rather than prescriptive.

Indeed, auditors of companies where overdrawn directors’ current accounts are in operation would need to ensure that the disclosures enable the financial statements to give a true and fair view in order to avoid any potential qualification to their auditor’s opinion.

Credit balances and withdrawals

Any withdrawals made by the director from bona fide credit balances on their current accounts cannot be constituted as an advance because these are simply repayments of funds previously invested in the company by the director and therefore should not be treated as an advance.

While such transactions are not considered to be advances to directors, they might be caught under the related party provisions and hence might need disclosure as a related party transaction.

It is also worth noting that a loan to a small company reporting under FRS 102, Section 1A Small Entities, which is material and is below market rates of interest (and stated at transaction price in accordance with the simplification in FRS 102, paragraph 11.13A(a)) would be caught under the related party disclosure requirements as the loan has not been concluded under normal market conditions.

Director resigns part-way through the accounting period

Section 413(6) of the CA06 says that references to a director in section 413 relate to any persons who were a director at any time in the financial year to which the accounts relate. Therefore, if a director resigns part-way through the accounting period, then section 413 will still apply to that person.

In addition, section 413(7) says that the requirements of section 413 apply in relation to every advance, credit or guarantee subsisting at any time in the financial year to which the accounts relate:

(a) whenever it was entered into;

(b) whether or not the person concerned was a director of the company in question

at the time it was entered into; and

(c) in the case of an advance, credit or guarantee involving a subsidiary undertaking of that company, whether or not that undertaking was such a subsidiary undertaking at the time it was entered into.

Conclusion

This article has considered the company law aspects of directors’ current accounts and it is important that such protocol is correctly followed in order to avoid any contentious issues which may arise further down the line.

Be careful with issues such as disclosures and templating these disclosures and ensure that any material advances and repayments are separately disclosed (especially where the client is audited as inadequate disclosures in respect of directors’ transactions will invariably lead to a modified auditor’s opinion).