ACCA - The global body for professional accountants

Audit and Society

research-insights145

Allowing medium-sized companies to dispense with audits could increase their costs of capital and have wider consequences, says ACCA’s Sue Almond

Over the years we have become used to the audit exemption thresholds for small companies being gradually increased. The rise is especially marked when governments are keen to be seen to be cutting ‘red tape’ for small entities. For smaller and owner-managed companies the benefits of an audit may indeed be outweighed by the costs, and it is for this reason that ACCA believes that the audit of small companies should be voluntary rather than mandatory.

However, a worrying new development has emerged in Europe in the past 12 months – the proposal to exempt medium-sized entities too from the mandatory audit requirement. The proposal has not progressed, but the seed may have been planted in the minds of legislators, so it is timely to consider the cost benefit equation and the possible impact.

First, it is important to define ‘medium sized’. The criteria in the EU are turnover between €8.8m and €35m, a balance sheet total of between €4.4m and €17.5m, and a headcount of between 50 and 250 employees.

In many countries, and in large countries within the local environment, businesses of this size may well be regarded as large by many people. Certainly, such enterprises may provide significant employment in the area and support a strong supply chain. They may well be involved in international activity, which stimulates trade and awareness of the local area. If such a business were to fail or relocate, there would likely be a serious local impact.

These businesses also have a broader impact. As well as their direct tax contributions, they are effectively tax agents responsible for collecting significant indirect taxes – a burden that many businesses are all too aware of. Sales taxes (say 20% of turnover) and payroll taxes (perhaps 40% of payroll cost) result in substantial payments to government.

So to what extent is an annual audit a burden on medium-sized business, and what else can it be said to contribute to society?

Medium-sized businesses are critical to economies but typically lack the resources to develop the systems or sophisticated finance functions expected of a large entity. Yet they may not be simple owner-managed businesses; often there will be some outside investment, or in the case of a family business there may well be non-working family shareholders. Such a business is no longer ‘small’, and has broader stakeholders, and hence responsibilities, than a typical owner-managed business.

The underlying concept of the annual audit is to provide stakeholders with assurance on the annual accounts. But the process of providing this assurance has many side benefits to the business and its stakeholders, and ultimately helps to underpin the orderly conduct of the business community. The very fact that ‘the auditors are coming’ provides a timeline and discipline for many businesses to complete the annual reporting process.

The pure audit process itself includes the assessment of risk, consideration of controls, discussion of fraud, and consideration of going concern – all areas of intense interest for the broader stakeholder group. The auditor acts as society’s eyes and ears in areas such as bribery and money laundering, and has whistle-blowing responsibilities.

The auditing process involves considerable discussion with the business’s managers, which in some cases will be an opportunity to debate the issues facing the business, and to encounter robust and independent challenge on the business plans.

While the prompt for such discussions may be audit-related, and there is rightly concern over the extent of non-audit services auditors should provide to clients, it is naïve to expect these discussions to be purely one-dimensional. As the auditor typically has a broad client base, the discussion will often include comparative feedback and suggestions from the auditor – to use an unfashionable term ‘business advice’ – that is particularly valued by the business.

So what would be the impact if the audit requirement were to be removed?

It is tempting to assume that in the short term there would be cost savings on the annual audit. But what we have typically found when small audit thresholds have been raised is that accountants have become more adept at articulating the value of what they bring to the business and have simply repackaged this, rather than relying on the mandatory statutory audit to open the door. So there may in fact be less direct cost saving than may be assumed, although, ironically enough, businesses are happier because the purchase is a voluntary one rather than imposed.

But it is the broader, longer-term potential impact that is probably more concerning. There is evidence that a business’s access to finance, and its cost of capital, is impacted by whether or not the financial statements are audited. There are also signs that assurance requirements may be imposed on unaudited businesses via the supply chain.

 

The big question

The big, unanswered question is what the response of the tax authorities will be. Many countries are already moving to a more risk-based tax investigation regime, which could be seriously undermined without a statutory audit environment. So it is perfectly possible that the perceived cost savings will simply be a cost-moving exercise – either straight back to the business, or indirectly via the cost of administering the taxation system.

It is also important to remember that it is not just about cost. The intangible benefits of regular inspection and dialogue with an independent professional could also be lost.

ACCA is clear that there is real benefit for business and society in maintaining the requirement for the audit of medium-sized entities. But we also accept that the current role of audit must evolve to meet changing business needs – whether that is the overall scope of the audit, the quality of auditor reporting or in the development of narrative reporting and integrated reporting. The challenge for the audit profession is to make sure that the audit remains useful and relevant to business – and that we are not shy in articulating the benefits that it brings.

 

Sue Almond is ACCA’s technical director. Her role is to influence debate on technical issues affecting business and accountancy around the world. She spent over 20 years with Grant Thornton UK as national assurance services partner.

This article first appeared in Accountancy Futures, Edition 6, 2013

 

 

 

Published: 23 Aug 2014