Definition of Solvency

[Lobby]

Hi,

In my line of work I require an annual licence from the state, and as part of that process my auditor must provide a certificate stating that the company is being run OK etc. But most importantly, it must state that the firm is "solvent".

About a year ago, I took out an overdraft for 30K which I'm now using almost fully. The overdraft is not due up until Sept 2012. Most of the overdraft was used in hoping the situation would improve and I retained a staff member for longer than I probably should have. Between salary for her and redundancy payments about 17K of the overdraft was used. The remainder was used for payments to myself (income/expenses).

Since then, my situation has changed for the better, business has improved, and my wife now has a very good job which means I can concentrate on working out the overdraft and do not require to take any income from the firm until I repay the loan.

But, as of end 2010, the firm had an overdraft of 30K, and assets totalling about 5K (its a service business so there's no stock/significant fixtures/fittings/machinery to bolster assets). Due to this the accountant claims the firm is insolvent as liabilities exceed assets. I disagree and claim that the firm is not insolvent as I understand insolvency to mean an "inability to pay debts as they fall due". This I can do, as the overdraft is now down to about 18K with a further 20K or so due in fees in the coming months.

The auditors only suggestion to remedy the situation and for him to issue the cert is to inject capital of c. 15K (share capital) into the business to meet the shortfall.

This is pretty much a paper exercise (other than the transfer of money) as the firm is trading, is meeting all its bills (there are no outstanding invoices due for payment) and the overdraft isn't due until Sept 2012.

Any ideas/suggestions on this? Is the above firm "insolvent"?

For example, "thinking outside the box" (I hate that phrase!!) - I own a car worth about 18K (no loans on it), could I "sell" the car to the firm for €1, and effectively increase the assets? (This is "kicking the can down the road" as I would face the same issue next year unless I have paid off the overdraft, which I hope to do, and have the projected business to do)

Even injecting some savings into the company to pay the overdraft won't rectify things, as from the companies perspective it would then have a loan to me, instead of to the bank.

 

[J.Ryan]

In company law Solvency is defined as the ability to pay your debts as and when they fall due.

What is your line of business?

 

[Lobby]

I'm an estate agent/valuer. Most income is from valuations (banks/probate/divorce cases) rather than property sales in the last 12 months.

I agree with your definition of solvency, but how to convince the accountant?

 

[Brendan Burgess]

I agree with your accountant and I think so would the Revenue. If he gave you a certificate saying you were solvent and you subseqently went to the wall, then the creditors might have something to say about it.

In ordinary companies, the audit cert says something along the lines of "the company is dependent on funding from directors who have indicated that they will support the company..." Would that satisfy him/

Don't inject ordinary share capital as it will be very difficult to get out.

I presume it's a limited company, although I note you use the word "I took out an overdraft"?

Can you refund your salary? This would put cash back in and possibly get a tax refund.

Consider putting in redeemable preference shares instead of ordinary share capital, so that when the company is profitable again, it can refund the capital.

 

[Lobby]

I agree with your accountant and I think so would the Revenue. If he gave you a certificate saying you were solvent and you subseqently went to the wall, then the creditors might have something to say about it.

Thanks Brendan, the company won't be going to the wall, I gave a personal guarantee for the overdraft and if worst were to happen and I closed shop then I can repay the bank. My intention is to trade through the next while and eliminate the overdraft (now that I can do so without requiring any income from the firm/staff costs), then review if it's worthwhile continuing as I can fall back on another career.

In ordinary companies, the audit cert says something along the lines of "the company is dependent on funding from directors who have indicated that they will support the company..." Would that satisfy him/

I'll enquire but the cert for an EA is mainly concerned with the Client account (which is in good standing) and then a one liner stating "the firm is solvent"

Don't inject ordinary share capital as it will be very difficult to get out.

Exactly my worry.

I presume it's a limited company, although I note you use the word "I took out an overdraft"?

Yes, and it is the Ltd Co that has the overdraft

Can you refund your salary? This would put cash back in and possibly get a tax refund.

I only drew about 6K last year in salary, so little tax refund there. but, I could possibly refund that to eliminate some of the shortfall.

Consider putting in redeemable preference shares instead of ordinary share capital, so that when the company is profitable again, it can refund the capital.

I'll look into this. Can that be a straight refund, i.e. no tax implications?

 

[J.Ryan]

I'm an estate agent/valuer. Most income is from valuations (banks/probate/divorce cases) rather than property sales in the last 12 months.

I agree with your definition of solvency, but how to convince the accountant?

My earlier defination is correct for company law, however this is a different matter, this is because you hold client funds a certificate has to be submitted under the Auctioneers and House Agents Act 1947 (Accountants Examination and Certificate) Regulations 1968.

However on the ACCA technical Factsheet 63, the following guidelines are given on Solvency

1. "an accountant shall not issue a certificate....if at the time of his examination matters come or have come to his notice from which it appears to him that the auctioneer or house agent is not solvent".
2. One opinion on the meaning of "solvency" is that it means the ability of the firm to meet their debts as they fall due and not just an excess of assets over liabilities.

 

[Lobby]

My earlier defination is correct for company law, however this is a different matter, this is because you hold client funds a certificate has to be submitted under the Auctioneers and House Agents Act 1947 (Accountants Examination and Certificate) Regulations 1968.

However on the ACCA technical Factsheet 63, the following guidelines are given on Solvency

1. "an accountant shall not issue a certificate....if at the time of his examination matters come or have come to his notice from which it appears to him that the auctioneer or house agent is not solvent".
2. One opinion on the meaning of "solvency" is that it means the ability of the firm to meet their debts as they fall due and not just an excess of assets over liabilities.

Thanks John, the accountant is an ACCA member so i'll put that to him.

 

[Lobby]

My earlier defination is correct for company law, however this is a different matter, this is because you hold client funds a certificate has to be submitted under the Auctioneers and House Agents Act 1947 (Accountants Examination and Certificate) Regulations 1968.

However on the ACCA technical Factsheet 63, the following guidelines are given on Solvency

1. "an accountant shall not issue a certificate....if at the time of his examination matters come or have come to his notice from which it appears to him that the auctioneer or house agent is not solvent".
2. One opinion on the meaning of "solvency" is that it means the ability of the firm to meet their debts as they fall due and not just an excess of assets over liabilities.

Actually John, as I read that, the insertion of the words "not just" seems to imply that the issue of assets exceeding liabilities is an underlying element that must be present in addition to being able to meet debts as they fall due. In other words, "assets exceeding liabilities" is a necessary but not sufficient condition of "solvency". But maybe I'm interpreting it wrong.

 

[J.Ryan]

I would take it as meaning an excess of assets over liabilities is not the only requirement of being solvent and likewise an excess of liabilities over assets might not make you insolvent.

 

[Brendan Burgess]

One opinion on the meaning of "solvency" is that it means the ability of the firm to meet their debts as they fall due and not just an excess of assets over liabilities.

I would think that a fundamental requirement of solvency is that the company's assets exceed its liabilities. But this statement is saying that this is required but not enough.

 

[Paddy199]

I would think that a fundamental requirement of solvency is that the company's assets exceed its liabilities. But this statement is saying that this is required but not enough.

I would agree 100% with this assessment.

I think you will have to demonstrate to the accountant with projections that you can meet your liabilities as they fall due. If an accountant has that as backup and it appears to be reasonable, they should issue the cert.

 

[Lobby]

I would think that a fundamental requirement of solvency is that the company's assets exceed its liabilities. But this statement is saying that this is required but not enough.

Hopefully, the fact that there's an ambiguity might be enough to work with.