Section 384A of the Companies Act 2006 sets out the size criteria that a company must meet in order to qualify as a micro-entity. The qualifying conditions will be met if the company is within at least two of the following three size thresholds:
Refer to section 384A and to the notes below for guidance on how to calculate these key company size thresholds:
Turnover:
This threshold should be proportionately adjusted if the accounting period is shorter or longer than 12 months. For example, if the accounting period were only for a nine-month period then the reduced turnover total would be £474,000 (being 9/12 of £632,000).
Balance sheet total:
The total of the amounts shown as assets on the balance sheet.
Average number of employees:
When calculating the average number of employees you should include any person normally employed by the company under a contract of service. This includes directors that have a contract of service but should exclude non-executive directors (if they do not have a contract of service), casual workers and sub-contractors.
The average should be calculated as described in section 384A(7):
- For each month in the financial period count the number of persons employed with a contract of service by the company in that month. They do not need to have been employed for the whole of the month.
- Add together all the monthly totals.
- Divide the total by the number of months in the financial period.
How many years must the company meet the size criteria for?
A company can qualify as a micro-entity in its first financial year provided it meets the size thresholds detailed above and it is not excluded on any other grounds, such as type of company or trading activity.
Succeeding years can be less straightforward as section 384A states that when “a company meets or ceases to meet the qualifying conditions, that affects its qualification as a micro-entity only if it occurs in two consecutive financial years.” This means that in subsequent years, a company must meet the qualifying conditions in both the current year and the year before.
However, if the company qualified as a micro-entity for the previous financial period but doesn’t meet the criteria for the current financial period, the ‘two consecutive financial years’ rule also means that they may continue to apply micro-entity provisions for the current year.
This is best illustrated with an example:
Company A qualified for micro-entity accounts for the previous financial period. However, it exceeds all the size thresholds for the current accounting period.
The ‘two consecutive financial years’ rule means that although Company A does not meet the qualifying conditions this year, because it did for the previous year it can continue to claim micro-entity exemptions again this year.
When Company A considers accounting exemptions next year – two different outcomes are possible:
1. If Company A can meet the qualifying conditions next year, then it reverts back to being considered a micro-entity and can continue to produce micro-entity accounts for a third year without interruption.
2. If Company A does not meet the qualifying conditions again next year, this is the second consecutive financial year that it has failed to qualify as a micro-entity and it will not be able to claim micro-entity exemptions when preparing accounts for that financial period.
*Note that when considering the 'two consecutive financial years' rule, what is important is determining whether the company met the qualifying conditions that would have enabled it to legitimately file micro-entity accounts in the previous period. It did not have to have actually filed micro-entity accounts.
Application of the 'two consecutive financial years' rule can be tricky, so the flow chart below has been designed to illustrate the logic. However, it may be advisable to consult an accountant if you are in any doubt:
