This article was first published in the April 2016 UK edition of Accounting and Business magazine.

Small companies whose vital statistics for two consecutive years fall below a new, higher threshold (see box) will no longer be required to have an audit. The move realigns the audit exemption threshold with small company limits and comes into effect for financial years beginning on or after 1 January 2016.

In reaching its decision, the Department for Business, Innovation and Skills (BIS) has been swayed by arguments that delinking the audit exemption threshold from the small company limits (set by the UK at the maximum allowed in the EU) would increase complexity in the financial reporting framework, and that a rise was needed to adjust for inflation. Counter-arguments warning of a greater risk of poor financial reporting were considered but set aside. 

ACCA’s response to the increased threshold is pragmatic, framed in the light of the restrictions imposed on UK regulations by the EU’s 2013 accounting directive. As Andrew Gambier, head of audit and assurance at ACCA, explains, small companies that apply financial reporting standard FRS 102 can, under the EU directive, be required to make a maximum of only 13 disclosures. 

However, their financial statements are still required to give a true and fair view. So what happens when an auditor thinks that a company should add an extra disclosure to achieve that true and fair view, but the directors are unwilling and point to the limited requirements of FRS 102? 

‘We could foresee quite a difficult set of negotiations between auditors and preparers in situations where the preparer doesn’t really want an audit,’ Gambier says. ‘Therefore, very reluctantly, we conclude that we are better off not requiring companies to have an audit at all in that situation, and allowing those that really want an audit to go and get it.’ However, without the complexity caused by the limit of 13 disclosures alongside the requirement for a true and fair view, ACCA would rather have kept more companies subject to the statutory audit requirement, seeing it as a valuable contributor to the achievement of high-quality financial reporting. 

As for audit firms, while they might be expected to wring their hands at the latest slice of mandatory audit work being taken away, this doesn’t seem to be the case.

Eye on the long term

One reason is that many companies eligible to drop their audit will refrain from doing so. Although around 7,400 companies are likely to be allowed exemption, the government expects that, based on current practice, 4,400 will retain the external audit. This may be because they value it or because of external market pressures. Banks and other finance providers, for example, may look more favourably on companies with audited accounts or even require an external audit before providing financial backing. 

Myfanwy Neville, partner with London/Cambridge-based firm BKL Accountants, says: ‘When the thresholds changed last time, a few of our clients who became exempt still wanted the rubber stamp of the audit. They wanted the comfort that somebody independent was looking at the figures and their systems – having a look under the car bonnet to check everything is OK.’ 

She also notes that growing companies may become audit-exempt for a few years but cross the threshold again a few years later. ‘The first year that they need an audit again, it may be quite expensive [if they haven’t continued to have an audit in the interim] because the auditors would need to look at the comparative figures too,’ Neville says. So for growing businesses, temporarily abandoning the audit might represent ‘a short-term saving that doesn’t really benefit them in the end’. 

A second reason for audit firm optimism is that, even when clients decide they no longer want or need a formal external audit, they may still seek some other form of assurance. ‘Businesses can get a lot of value from an audit-type assurance product that we make bespoke to them,’ Neville says. 

Essential role

Steve Gale, head of professional standards at Crowe Clark Whitehill, says: ‘There can be some reasonably complex businesses with turnover of £8m or £9m. The vast majority will still want the involvement of finance professionals and accountants. There is an essential role for advisers such as ourselves in helping businesses achieve their aims. As a profession, we need to adapt and develop assurance offerings that support business owners and directors.’

Mark Lamb, head of owner-managed businesses at Moore Stephens, agrees. ‘Some business owners may be left feeling exposed if they have no independent checks,’ he points out. ‘We make it our business to advise clients on the best approach, and there are various non-audit services available that can deliver a more limited form of assurance compared to an audit.’ 

Non-audit assurance could include a review offering a lower level of assurance than an audit, with less detail and a lower price tag. Companies could also opt for internal controls assurance, giving them comfort on the design and operating effectiveness of financial reporting systems.

Lamb sees these latest changes to the audit exemption threshold as an opportunity for proactive and innovative accountants that serve growing businesses. ‘When you remove regulation, the need for more and better business advice is strong,’ he says. ‘As clients grow, their needs become more widespread. We have developed skills and competencies to be able to meet those needs.’

However, some have warned that raising the audit exemption threshold could increase the risk of fraud, with large unaudited businesses potentially hiding criminal – or even terrorist – activity. But this view isn’t universal. Gale, for example, doesn’t necessarily see a rise in the audit threshold as problematic. ‘Removing the statutory audit requirement doesn’t necessarily lead to a wholesale risk of fraud among these businesses,’ he says. ‘We support a deregulatory agenda, which will encourage business growth and entrepreneurship.’ As he points out, some safeguards are in place – for example, requiring subsidiaries of larger groups to be audited and protecting the rights of minority shareholders.

The shadow of the EU inevitably falls on any discussion of small company limits and the audit exemption threshold. So what happens in the event of Brexit? One day we could be debating these issues all over again, but in a purely UK context. In any case, BIS will be watching out for any negative impacts of increasing the audit exemption threshold, warning that it will ‘respond quickly should evidence emerge that further action is required to ensure that the UK continues to have a world-class financial reporting and assurance framework which meets the needs of users and regulators’. 

Sarah Perrin, journalist

Swipe to view table

Audit exemption threshold

  New Old
Turnover £10.2m £6.5m
Balance sheet total £5.1m £3.26m
Number of employees 50 50