Annual Financial Statements:Fundamental Differences in Law Between

Companies and Sole Proprietors

Monique SharlandCEOBusiness Accounting Network

Going Beyond Accounting, Taking Your Business Forward

Close Corporation Status• Close Corporations can no longer be formed (since May 2011).

• Close Corporation’s are included under certain provisions of the Companies Act.

• Close Corporation’s are not required to be independently reviewed under the Companies Act but if certain criteria are met, are required to be audited.

• Financial reporting standards related to financial statements of Close Corporations falls under the Companies Act and is treated in the same way as companies.

Close Corporation Status

The future of close corporation’s and the CC Act will eventually, in time to come, be dissolved leaving business owners to decide whether to:

• Convert the close corporation to a company, or

• “sell” the business as a going concern back to the member (sole proprietor) or members (partnership).

Legal Statutes

Legal Statutes Company Sole Proprietor

Companies Act Yes No

Income Tax Act Yes Yes

Tax Administration Act (TAA) Yes Yes

Other related acts, e.g. VAT Yes Yes

Legal implications Onerous and expensive Simple and inexpensive

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Management

Relationship Company Sole Proprietor

Ownership Shareholders (can be natural person, company, trust) Natural person

Management Director = natural personNot necessarily a shareholder Owner = natural person

Employer/Employee Relationship

Company = employerDirector = employee Subject to PAYE on remuneration

Sole Proprietor cannot be the employer of him or herself – no employment relationship.Not subject to PAYE

Legal status

Company Sole Proprietor

Longevity

Business continues after the owner dies (provided there is a succession plan in place)

Business dies upon death of owner

Personal Liability Limited personal liability – directors can be held personally and criminally liable under certain circumstances

No limited personal liability

Accounting Records – Legal Basis

Company Sole Proprietor

• Explicitly governed by the Companies Act Regulations

• Onerous• Includes all company secretarial documents• Criminal offence if transgressed• Income Tax Act• Tax Administration Act• VAT Act

Governed by:• Income Tax Act• Tax Administration Act• VAT Act

Less onerous

Accounting RecordsCompany Sole ProprietorSame as for sole proprietors plus:• Fixed asset register• Loans to and from company shareholders,

directors, employees and prescribed officers• Record of all liabilities, including guarantees,

suretyships or indemnities granted by co.• Record of property held in a fiduciary capacity

including refundable deposits• Statements of every account held at financial

institutions• Inventory records

Customer invoicesSupplier invoicesReceipts Bank statementsCredit card statementsInvoices for asset acquisitionsDetails of assets sold, amount, date and to whomCash book

Company Secretarial Records

Company Sole ProprietorMemorandum of Incorporation (MOI)Share certificates Shareholders registerCompany register• Records of the company’s directors• Reports to annual general meetings and annual

financial statements• Notices of meetings• Resolutions and special resolutionsAnnual Duty return – submission of FAS

Not applicable

Characteristic of CompaniesCompanies require an Independent Review if:

1. The company’s PIS score is over 100 but under 350,or2. If the PIS score is under 100 and the company is non-owner managed or3. If an independent review is required in terms of the company’s MOI

What is owner managed?All shareholders are also directors. Therefore, if a company has another company or a trust as a shareholder, neither of these shareholders can possibly be directors and therefore the company would be non-owner managed.

Independent ReviewWhat is an independent review and how does it compare with an audit? • An independent review - new companies act, promulgated in May 2011• The work involved is approximately 60% to 70% of that of an audit.• An independent review is a “negative assurance test”, that is, the work does

not need to be carried out at the company’s premises, unlike an audit, which is a “positive assurance test”.

• An independent reviewer’s report to the annual financial statements provides limited assurance only. An audit provides assurance.

• Independent reviewer and compiler cannot be one and the same.• Not required by most small companies if structured correctly under their

specific circumstances.

AuditDispelling Myth #1Because you have an audit firm prepare your annual financial statements does not mean that your company or business has been audited.

No audit means:• No assurance will be provided in their report (to the financial statements). • Not designed to detect fraud or other devious or dishonest activities.• An audit is onerous, time-consuming, complex, strategic and methodical –

and requires top skills (partner or audit manager), many positive verifications and analytical tests – hence cost.

Income Tax Basis

Company Sole ProprietorIncome tax payable on company’s net taxable profit after deducting director’s remuneration, which is subject to PAYE.

Income tax paid on net taxable profit only.

Dispel myth #2:Drawings by the owner is not regarded as a taxable “salary” therefore drawings has no bearing on income tax – only has a bearing on possible solvency.

Income Tax Rates

Company Sole ProprietorCompany tax (IT14 return):

1) 28% of net taxable profit2)Small Business Corporation (SBC) tax

rates if a qualifying small business

PLUSDirector’s PAYE (EMP201 return)

• Individual tax rates per tax tables• IT12 return

Individual tax rates per tables (IT12 return)

Financial Reporting StandardsIFRSNot applicable to small companies or companies that do not require an audit

IFRS for SME’sFair value basisProfit or loss does not equate to taxable profit or loss

Tax baseHistorical cost baseProfit or loss equates to taxable profit or loss, excluding permanent differences

IFRS for SMEIFRS for SME’s

• Fair value of all assets and certain liabilities;• Tailored for small companies;• It focuses on information needs of lenders to the company;• Internationally recognized;• Increases comparability between companies and improves the efficiency of

business across borders.

Financial Reporting Standards

Company Sole Proprietor

Legal statusGoverned by both the Companies Act and International Accounting Standards

Not applicable

Comprising• IFRS (if audited)• IFRS for SME• Own framework (tax base)

Tax base only

Financial StatementsCompany Sole Proprietor

Comprising

• Compiler/independent reviewer reports• Statement of Financial Position• Statement of Comprehensive Income• Statement of Expenses• Cash flow statement• Notes relating to the results (minimum

requirements per Companies Act)• IFRS for SME disclosures

Income statementStatement of Assets and Liabilities

Financial Statements Documentation

Company Sole Proprietor

Documentation substantiating

• Materiality calculation = test for misleading or false statements

• Working papers to substantiate all balance sheet accounts, income and expenditure and materiality assessments

• Comply with ISRS 4410 (compliance with law and integrity)

Not applicable

ISRS 4400 – agreed upon services

ResponsibilitiesCompany Sole Proprietor

Compliance with the Companies Act and Regulations

Director/s Not applicable

Accounting records Director/s Owner

Company secretarial records Director/s Not applicable

Financial statements Director/s Not applicable

Annual financial statements Director/s Not applicable

Annual income statement and statement of personal assets and liabilities

Not applicable Owner

All tax matters, including income tax, VAT, employee taxes

Director/s Owner

Example

Now let’s take a look at an example of the following for comparison:

1 Annual financial reports required of a sole proprietor

2 Annual financial statements of a company

Conclusion

Companies are a far more expensive entity to run than a sole proprietor.

• If you are an owner-managed small business trading in acompany, consider obtaining advice from your accountant todetermine the correct and most cost effective structure foryour business.

Join us for the next of our Business Webinar series:

ANNUAL FINANCIAL STATEMENTS:IFRS for SME compared to Tax Base Accounting

Understanding your financial resultsA webinar made simple for the SME business sector

27th June 201909h00 – 10h00

Questions?