Essential checklist for accounting records before undertaking a Small Business Restructuring

In article:

What are the key accounting records required for a successful SBRP?

1. A comprehensive creditor listing, including statutory debts
2. A complete listing of all company property
3. Final financial statements prepared by the company’s external accountant
4. Reconciled accounts for the period following the preparation of the final financial statements by the company’s external accountant

If a business is already insolvent, one might wonder about the necessity of preparing its financial records for an incoming Restructuring Practitioner. The answer lies in the manifold uses of financial information: facilitating reports to creditors, enabling the Practitioner to issue a certificate of compliance, and supplying accurate data to the Australian Taxation Office (ATO) for securing its vote of approval. Notably, while the ATO is a generous creditor in an SBRP context, it does demand attention to detail.

What are the obligations of a Restructuring Practitioner regarding accounting records?

The obligations of the Restructuring Practitioner extend beyond mere supervision of financial affairs. Under Corporations Regulations (Regulation 5.3B.18), the Practitioner is required to personally examine the financial affairs of the company subject to restructuring. The Restructuring Practitioner is required to given a personal assurance (through a declaration) that the eligibility criteria are satisfied, and the company is likely to meet a proposed restructuring plan’s requirements – essentially, honouring the amounts promised to the creditors as a compromise. 

Particularly, under Corporations Regulation 5.3B.18 the Restructuring Practitioner must:

1. Prepare a declaration under this regulation, and
2. Make reasonable inquiries into the company’s business, property, affairs, and financial circumstances, and
3. Take reasonable steps to verify the company’s business, property, affairs, and financial circumstances

What type of information does the ATO seek?

Creditors in a SBRP have limited rights to request information and there is no meeting of creditors. The process was designed to fast-track restructuring by giving creditors a simple offer (for cash) without requiring detailed reporting that is expected in a Voluntary Administration. Even for a small Voluntary Administration, extensive financial analysis and reporting is required. Nevertheless, the ATO has informed the insolvency profession that it expects to receive more financial information than that required in standard creditor reporting. The information that the ATO expects to receive from a Restructuring Practitioner includes:

• A summary of the historical profit and loss accounts and balance sheets
• Details of assets as at the date of appointment
• A summary of the prospective financial information and assumptions relied upon for the restructuring plan
• The estimated dividend to creditors in a hypothetical liquidation
• Where there has been a material loan to or from directors, shareholders or related entities, copies of the relevant transaction listing reports

What is the ATO policy regarding restructuring plan approvals?

One of the key aspects of the ATO’s approach to restructuring plan approvals is to assist eligible businesses in accessing restructuring wherever it is viable and appropriate. The ATO’s overarching goals are to support business continuity, sustainability, and the enhancement of financial health over time.

The ATO typically supports a restructuring plan as long as it does not possess any adverse elements. The preference lies in strategies that will yield the Commonwealth a larger proportion of the admissible debt over a reasonable timeframe compared to what would be attainable through a liquidation process. Thus, the ATO’s policies are aimed at promoting restructuring as an alternative to closing down businesses entirely, where possible.

The ATO’s decision on whether to vote for a restructuring plan is comprehensive, taking into account a multitude of relevant factors. One key reference point for this decision-making process are the general factors stipulated in paragraph 32 of the Law Administration Practice Statement PS LA 2011/16. This ensures that any decisions are underpinned by legal guidelines, reflecting the principle of fairness.

Further, the ATO displays a collaborative approach towards restructuring, especially when the ATO itself is the dominant creditor. In this scenario, the ATO may open to providing feedback on preliminary restructuring plans before they are finalised. This not only promotes transparency in decision-making but also enables businesses to align their restructuring plans with ATO’s preferences and requirements.

The consequence of this ATO policy is that a Restructuring Practitioner needs to supply more detailed information to the ATO to secure its support for a restructuring plan, including:

• A summary of the historical profit and loss accounts and balance sheets
• Details of assets as at the date of appointment
• A summary of the prospective financial information and assumptions relied upon for the restructuring plan
• The estimated dividend to creditors in a hypothetical liquidation
• Where there has been a material loan to or from directors, shareholders or related entities, copies of the relevant transaction listing reports

Are balanced books an essential requirement for a successful SBRP?

Most insolvent small and medium sized businesses go into external administration without “balanced books”. In the simplest terms, having balanced books in accounting means that your total debits equal your total credits. It’s a fundamental concept that stems from the double-entry bookkeeping system.

In this system, each financial transaction is recorded in at least two different accounts: one account is debited (increased), and another account is credited (decreased). The total amount of debits should always equal the total amount of credits. This helps to ensure the accuracy of financial records and provides a clear picture of a company’s financial health.

Balancing company accounting isn’t just about making sure the numbers add up. It’s also about understanding where money is coming from and where it’s going (i.e. cashflow analysis). 

The takeaway is that although there is no precise requirement that a company reconcile its accounts as part of a restructuring process the Restructuring Practitioner needs to be able to get enough information from accounting software and records to advocate a restructuring proposal to creditors (including the ATO) and to make a declaration in support of the plan offered. 

So what can a company do to maximise the chance their accounting information will be enough to satisfy the Restructuring Practitioner, the ATO and creditors? 

1. Chart of Accounts:

Review and update your chart of accounts to accurately reflect the current state of your business. Ensure that it aligns with your SBRP goals and any changes in your operations, products, or services. Remove obsolete accounts and add new accounts as necessary.

2. General Ledger:

Perform a detailed review of your general ledger to confirm that all transactions are recorded accurately and categorized correctly. Verify the accuracy of account balances and reconcile any discrepancies. Ensure that all journal entries are adequately supported by appropriate documentation.

3. Bank Reconciliation:

Reconcile all bank accounts to ensure that your records match the bank statements. Investigate and resolve any discrepancies, such as outstanding checks or deposits in transit. Document any necessary adjustments and update your records accordingly.

4. Accounts Receivable:

Review your accounts receivable aging report to identify any overdue or delinquent customer accounts. Take necessary actions to collect outstanding payments, send reminders, or establish payment arrangements. Update your records to reflect any adjustments or write-offs.

5. Accounts Payable:

Review your accounts payable aging report to identify any outstanding bills or invoices. Confirm that all liabilities are accurately recorded and up to date. Verify that you have received all goods and services for which you have been billed.

6. Inventory:

Conduct a physical inventory count and reconcile it with your accounting records. Identify and investigate any discrepancies. Review your inventory valuation method and make adjustments if necessary to reflect the true value of your inventory.

7. Fixed Assets:

Review your fixed asset register and ensure that all assets are properly recorded, classified, and depreciated. Update the register to reflect any additions, disposals, or impairments of assets. Verify the accuracy of depreciation calculations.

8. Payroll Records:

Review your payroll records, including employee wages, benefits, and taxes withheld. Ensure that all payroll transactions are accurately recorded, and that payroll taxes are correctly calculated and remitted. Confirm that employee information is up to date.

9. Financial Statements:

Prepare and review your financial statements, including the balance sheet, income statement, and cash flow statement. Analyse the financial health of your business and identify any areas that require attention or improvement. Ensure that the financial statements comply with applicable accounting standards and regulations.

10. Documentation and Compliance:

Ensure that all supporting documentation for your accounting records is properly organized, labelled, and readily accessible. This includes invoices, receipts, bank statements, contracts, and any other relevant financial documents. Review your compliance with accounting and tax regulations to mitigate any potential risks.

Do you need to have all tax returns lodged and employees paid in full before a company enters the SBRP?

Before embarking on a business restructuring journey under Part 5.3B of the Corporations Act, it is crucial to understand obligations regarding tax returns and employee entitlements. One of the common queries from businesses before starting restructuring is whether they need to have all their tax returns lodged and all employee entitlements paid before the appointment of a Restructuring Practitioner. The answer is no, these are not preconditions for the appointment. However, it’s worth noting that substantial compliance with payment of employee entitlements and tax lodgements is a prerequisite for a restructuring plan’s approval.

What does this mean for an insolvent business? Essentially, it must demonstrate a good faith effort to stay up to date with these financial obligations, which is a show of fiscal responsibility and ensures a smooth restructuring process. As a part of meeting this eligibility criterion, a business is expected to be substantially compliant at the time the restructuring plan is proposed – approximately 20 business days after appointing a Restructuring Practitioner. 

Two key elements of compliance include:

1. Tax Lodgements: Your business needs to be up to date with all tax lodgements, including tax returns and activity statements.

2. Employee Entitlements: Similarly, staying up to date with employee entitlements, such as wages, superannuation, and leave, is another pivotal aspect. It underscores the company’s commitment to maintaining a fair work environment and upholding its responsibilities to its employees.

Achieving and maintaining substantial compliance might seem daunting, but remember, it’s a strategic investment in your business’s future. Demonstrating financial responsibility and diligence can facilitate the restructuring process, helping your business bounce back stronger and more resilient. There is no case law on what “substantial compliance” means but if a company has only missed its last BAS lodgment or any non-compliance does not have any material effect on the company’s financial position the Restructuring Practitioner has the discretion to allow the restructuring proposal to go ahead. The purpose of the “substantial compliance” test must be to allow a company restructuring to continue even though there has been a technical or immaterial breach of the legal requirements for tax lodgment. 

The precise legal requirement regarding tax lodgments and payment of employment entitlements is below:

CORPORATIONS REGULATIONS 2001 – REG 5.3B.24

Company under restructuring must do certain things

This regulation is satisfied in relation to a company under restructuring if:

(a) the company has:

(i) paid the entitlements of its employees that are payable; and

(ii) given returns, notices, statements, applications or other documents as required by taxation laws (within the meaning of the Income Tax Assessment Act 1997 ); or

(b) the company is substantially complying with the matter concerned.

Note: Employee entitlements  are defined in subsections 596AA(2) and (3) of the Act and include superannuation contributions payable by the company.

Takeaways:

A thorough internal review of your accounting records is crucial before embarking on a Small Business Restructuring Process (SBRP). By following this checklist, you can ensure that your accounting records are accurate, complete, and compliant. By doing so, you will not only have a solid foundation for your SBRP but also gain valuable insights into the financial health of your business. Remember, well-maintained accounting records are essential for informed decision-making and long-term success.