The impact of a conversion in corporate form on companies’ financial reporting | In Principle

This issue continues to raise numerous doubts under Polish law. The doubts surround the number of financial statements required by law to be prepared in relation to the conversion, the reporting period covered by each financial statement, and the obligation for the financial statement to be examined by an auditor and approved by the competent body. Of particular importance is the correct determination of the period for which the first annual financial statement of the company post-transformation (the “new” company) must be prepared, which directly affects the method for distribution of profit from the company prior to transformation (the “old” company) and the limitations on distributions.

In response to doubts raised by the Polish Chamber of Statutory Auditors (PIBR), the Ministry of Finance has issued guidance in this regard (in particular, letters from the ministry’s Department of Public Expenditure Effectiveness and Accounting of 29 June 2020 (DR1.5101.11.2.2020, responding to PIBR letter of 19 December 2019) and 9 July 2021 (DWR5.5101.82.2021, responding to PIBR letter of 18 March 2021). Nonetheless, the reporting practice of units that have undergone a corporate conversion is still not uniform.

Classification of financial statements

First some points of order on the classification of financial statements under Poland’s Accounting Act. The act distinguishes between “annual financial statements” and “other financial statements,” depending on the time the statement is prepared and reason it is prepared.

The Accounting Act ties the obligation to prepare financial statements to closing of the unit’s accounting books, which is mandatory in the cases indicated in Art. 12(2) of the act—among other things:

• Periodically, as of the end of the unit’s financial year (Art. 12(2)(1))
• On the date of a merger in which the unit is taken over by another unit (for the unit being acquired, Art. 12(2)(4))
• As of the day before the unit is placed in liquidation or is declared bankrupt (Art. 12(2)(6))
• As of the day before a change in the unit’s legal form (Art. 12(2)(2)).

Thus, under the Accounting Act, annual financial statements are financial statements prepared as of the end of the financial year (Art. 45(1) in conjunction with Art. 12(2)(1)), where the financial year or a change in the financial year is determined by the articles of association under which the unit was established (Art. 3(1)(9)).

Any financial statement prepared as of a balance sheet date other than the end of the financial year is a financial statement other than an “annual financial statement” (Art. 45(1) in conjunction with Art. 12(2)(2)–(7)).

The Accounting Act distinguishes between two categories of financial statements:

• “Annual financial statements” (prepared as of the end of the financial year)
• “Other financial statements” (prepared as of another balance sheet date).

Financial statements prepared in connection with conversion

Two types of financial statement are required for the immediate needs of the conversion of corporate form of a company (or partnership) governed by the Commercial Companies Code:

1. Financial statement prepared for purposes of conversion (Commercial Companies Code Art. 558 §2(4)). This statement should be prepared as of the same date as of which the balance sheet value of the property of the company being converted is determined, i.e. as of a specific date in the month preceding submission of the draft terms of conversion to shareholders of the company being converted (using the same methods and in the same layout as the last annual financial statement of the company).
2. Financial statement as of the day before the change in legal form of the unit (Accounting Act Art. 45(1) in conjunction with Art. 12(2)(3))—pursuant to Commercial Companies Code Art. 552, the date of the change of legal form of the company is the date of entry of the “new” company in the commercial register.

Closing of the accounting books on the day preceding the conversion, and subsequently opening the accounting books of the “new” unit on the date of conversion, has the effect of cutting short the last financial year of the “old” company and starting the first financial year of the “new” company. This has significant implications for the distribution of profit from the “old” company, which in principle is frozen until the first annual financial statement of the “new” company is approved.

The Accounting Act also provides for certain simplifications allowing the company to skip the closing and reopening of the unit’s accounting books despite the company’s conversion. This may be applied in the case of conversion of a partnership under the Commercial Companies Code or a partnership under the Civil Code (spółka cywilna) into another partnership, as well as conversion of one type of company into another type of company (Accounting Act Art. 12(3)(1)). Thus, this exemption will also apply to conversion of a limited-liability company (sp. z o.o.) into a joint-stock company (SA) and vice versa.

The following reports may also be directly related to the conversion:

3. Separate financial statement as of another balance sheet date (Accounting Act Art. 45(1) in conjunction with Art. 12(2)(7)), if provided for by separate regulations, in particular when the reorganisation is due to tax considerations. In recent years, a large share of corporate conversions have been driven by the desire to take advantage of a form of deferred taxation referred to as “Estonian CIT.” In particular, the choice of this form of taxation is possible even before the end of the unit’s adopted financial year, provided that on the last day of the month preceding the first month of lump-sum taxation the unit closes its accounting books and prepares its financial statement in accordance with accounting regulations (Corporate Income Tax Act Art. 28j(5)).
4. First annual financial statement of the newly converted company (Accounting Act Art. 45(1) in conjunction with Art. 12(2)(1)).

Under the foregoing systematic scheme, the statement indicated in point 4 is an “annual financial statement” of the “new” company, while the financial statements in points 1 through 3 are “other financial statements” of the “old” company.

Requirement for audit and approval of financial statements prepared in connection with a conversion

Accounting Act Art. 64 requires auditing of the annual consolidated financial statements of capital groups and the annual financial statements of continuing units indicated in the act. As a result, under the act, of the aforementioned financial statements, the following will not have to be audited:

• Financial statements prepared for purposes of conversion
• Financial statements prepared in connection with closing of the unit’s accounting books as of the day before the change of legal form
• Statements prepared as of another balance sheet date (if the obligation to prepare them arises).

The Polish Accounting Act imposes an obligation for financial statements to be examined by a statutory auditor and approved by the competent body only in relation to annual financial statements.

As with the requirement for auditing of financial statements, the requirement for approval of financial statements is specified by the Accounting Act only in relation to annual financial statements (Art. 53). Hence, under the act, the following do not require adoption of a resolution by the competent body approving the statement:

• Financial statements prepared for purposes of conversion
• Financial statements prepared in connection with closing of the unit’s accounting books as of the day before the change of legal form
• Statements prepared as of another balance sheet date.

The foregoing principles for auditing and approval of financial statements have been confirmed in letters issued by the Ministry of Finance.

However, the requirements arising from other regulations must also be taken into account.

First, after the amendments introduced in 2020, the draft terms of conversion of a company (or partnership) must be audited if the company is being converted into a joint-stock company (Commercial Companies Code Art. 559). That audit concerns the correctness and reliability of the draft terms of conversion, as well as whether the valuation of the property (assets and liabilities) of the company being converted is reliable. Since the financial statement prepared for the purpose of conversion is an appendix to the draft terms of conversion, it will have to be audited in that case.

Second, the provisions of the Commercial Companies Code on approval of financial statements by the competent body refer literally not to approval of “annual financial statements,” but approval of “financial statements for the previous financial year” (e.g. Art. 146 §1(1), 231 §2(1) or 395 §2(1)). Since the closing of the accounting books of the “old” company as of the date of the conversion results in cutting short the financial year, it is functionally reasonable to take the approach that the shareholders of the “old” company should vote on a resolution to approve the financial statement for the period of the last financial year. This solution is justified even though opening of the “new” company’s accounting books as of the date of the unit’s change in legal form (Accounting Act Art. 12(1)(3)) formally begins the running of the first financial year of the “new” company. Application of this approach is also justified with respect to other interim financial statements of the unit that do not constitute an “annual financial statement” of the unit for purposes of the Accounting Act. This will guarantee the unit’s shareholders direct control over each period of the unit’s operations in a given calendar year for which a financial statement must be prepared pursuant to the Accounting Act.

First annual financial statement of the “new” company

In practice, the doubts regarding the reporting period for which the first annual financial statement of a newly converted company must be prepared have led to creation of two competing models.

First option

In the first option, the annual financial statement of the “new” company is prepared for the period from the date of the last opening of the accounting books in the first financial year of the newly converted company through the date ending the company’s first financial year. This approach is consistent with the systematic classification of financial statements adopted in the Accounting Act.

Example 1.

On 1 July 2022, a general partnership (s.j.) whose financial year is equivalent to the calendar year was converted into a joint-stock company whose financial year is also equivalent to the calendar year. For the general partnership, the prerequisites giving rise to the obligation to have its annual financial statement examined by a statutory auditor (Accounting Act Art. 64(1)(4)) have been met.

In this case, the following statements will have to be prepared:

• Financial statement for the period 1 January – 30 June 2022
• Financial statement for 1 July – 31 December 2022.

Under the Accounting Act, the only annual financial statement requiring examination by a statutory auditor and approval by the general meeting of the joint-stock company (the competent body) is the company’s financial statement for 1 July – 31 December 2022.

The financial statement for 1 January – 30 June 2022 will be a financial statement other than an annual financial statement. Thus, under accounting provisions, it will not require a separate audit, nor approval by the competent body. Nonetheless, functionally, it would be reasonable for them to be approved by the competent body pursuant to the Commercial Companies Code.

Example 2.

On 1 March 2022, a limited partnership (sp. k.) whose financial year is equivalent to the calendar year was converted into a limited-liability company (sp. z o.o.) whose financial year is also equivalent to the calendar year. Subsequently, on 31 August 2022, the limited-liability company closed its accounting books, which was required to change its form of taxation and take advantage of lump-sum “Estonian CIT.” Here, both the limited partnership (before conversion) and the limited-liability company (after conversion) met the prerequisites giving rise to the obligation to have their annual financial statements examined by a statutory auditor (Accounting Act Art. 64(1)(4)).

In this case, the following financial statements will have to be prepared:

• Financial statement for the period 1 January – 28 February 2022
• Financial statement for 1 March – 31 August 2022
• Financial statement for 1 September – 31 December 2022.

Under the Accounting Act, the only annual financial statement requiring examination by a statutory auditor and approval by the shareholders’ meeting of the limited-liability company (the competent body) is the financial statement for 1 September – 31 December 2022.

The financial statement for 1 January – 28 February 2022, as well as the financial statement for 1 March – 31 August 2022, will be financial statements other than annual financial statements. Thus, under accounting provisions, they will not require a separate audit, nor approval by the competent body. Nonetheless, functionally, it would be reasonable for them to be approved by the competent body pursuant to the Commercial Companies Code.

Second option

In the second option, the annual financial statement of the “new” company is prepared for the period from the beginning of the financial year of the “old” company through the end of the first financial year of the “new” company. If the financial years of the “old” and “new” companies are equivalent to the calendar year, and the conversion occurred on 1 March 2022, then under this model the first annual financial statement of the “new” company would be prepared for the period 1 January – 31 December 2022. Some auditors prefer this approach, pointing out that in choosing the first model, the period from the beginning of the financial year of the “old” company through the closing of its accounting books the day before the change in legal form would never be audited.

However, it should be pointed out that each time, information on the unit’s conversion and preparation of financial statements other than annual financial statements should be included in the notes, which form part of the annual financial statement. As a result, the financial statement with the data of the “old” company for the financial year in which the conversion occurred are subject to both audit and approval indirectly—at the stage of audit and approval of the first annual financial statement of the “new” company.

Nor is there a risk that the shareholders will be deprived of the right to dispose of the profit earned during this time. Any profit (or loss) generated during the period from the opening of the accounting books of the “old” company through the closing of its accounting books which occurs for a reason other than reaching the closing date of the financial year should be posted as retained earnings (or loss) from prior periods, and left to the disposal of the competent body considering the first annual financial statement of the “new” company and adopting a resolution approving the first annual financial statement.

Conclusion

The practice in determining the reporting period that should be covered by the first annual financial statement of a newly converted company or partnership in Poland continues to vary. This impacts the number and scope of the financial statements prepared, and also results in the lack of a uniform approach to auditing of financial statements and approval by the competent bodies.

On one hand, the Accounting Act distinguishes between “annual financial statements” and “other financial statements,” imposing an obligation for audit and approval only of annual financial statements. This approach is confirmed by guidance issued by the Ministry of Finance. But on the other hand, some auditors take the position that the audit should cover the entire period of operation of both the “old” company and the “new” company, or otherwise the shareholders would be deprived of full knowledge and control of the company’s operations during the interim period, which is not audited.

Thus, despite the wording of the Accounting Act and guidance from the Ministry of Finance, in practice, the recommended solution is to first consult with the statutory auditor on the model to be adopted for preparing the first annual financial statement of the “new” unit. Functionally, it is also reasonable for the competent body to pass a resolution in each case approving not only the annual financial statement (within the meaning of the Accounting Act), but also the interim financial statements relating to a reporting period for the unit that is not covered by the annual financial statement.

Dr Kinga Ziemnicka, attorney-at-law, Mateusz Próchnicki, adwokat, M&A and Corporate practice, Wardyński & Partners