Changes in Audit Exemption Thresholds in EU and UK
Question: Research the history of audit exemption in the European Union and discuss the changes in audit exemption thresholds in the United Kingdom.
In the European Union, the Parliament of Europe decides and governs which all are entities that are required to be subjected to the Statutory Audit and what all entities are exempted from this. Similarly, in the recent resolution of 2013 by the European Parliament, it was stated that all the companies, which have been specified as the small sector enterprises, or companies would be exempted from the requirements of the statutory audit (Boccia & Leonardi, 2016). So only, the public sector entities whose shares and securities are listed and traded on the stock exchange or are insurance providers or financial and lending institutions or those, which have been specifically named or prescribed by any member country of European Union, will be required to get statutory audit conducted. There have been many thresholds, which has been prescribed in the European Union for the entities, which will be exempted based on the balance sheet or the turnover analysis. These thresholds are periodically reviewed based on requirements and the limits have been lowered in 2013 as compared to those as stated in 2006 and 2011 regulations (Chron, 2017). As per the new regulation, a company can be categorized as the small sector undertaking in case it fulfils any of the two requirements of the three mentioned:
- The number of employees should not exceed 50 who are on payroll of the company
- The total of the balance sheet should not exceed 4 Mn Euros
- The net turnover of the company should not be more than eight Mn Euros.
However, since the various member countries have different issues therefore, they have been given an option to increase this limit to the maximum of EUR 6 Mn for balance sheet and EUR 12 Mn for turnover. In addition to these relaxations, the exchange rate fluctuation of 5% between the local currency and EURO has also been allowed by the legislation (Werner, 2017). In spite of this relaxation of the increase in the limits, the same has been exercised only by one third of the member countries and it is evident of the fact that how much reliance and trust is being placed on the role of the statutory audit of the enterprises. This is because audit helps in safeguarding the interests of the economy, the country and the shareholders at large. It has been stated that even the small companies can go for statutory audit on a voluntary basis if they want to get their accounts audited.
In the case of United Kingdom, the requirements do change a lot and the thresholds prescribed are on the higher end. Most of the requirements to be classified as the small companies are same as that of the small undertaking as prescribed above however, when it comes to defining the small companies (which do form a part of the group companies) to be eligible for audit exemption, the regulations do change a lot. Like those subsidiary companies, which do satisfy the conditions and provisions laid down in section 497A and do not fall under the classification laid down in Section 497B also qualifies for the exemption from statutory audit (Gooley, 2016). For UK is one of those countries which have utilised the benefit of increasing the threshold for exemption in terms of the balance sheet limits and the turnover limits and the increase in terms of pounds is quite significant. This move has primarily been taken by the US tax makers in order to remove the complexities, improve the ease of doing business and reduce the audit costs, thereby improving the country’s index and ranking (Guragai, et al., 2017).
Question: Present your arguments both for and against audit exemption for small companies
There have been many arguments both in favour as well as against the audit exemptions, which have been provided to the small companies. Arguments in favour of the exemption have been listed below:
- Audits are generally performed to keep the shareholders of the company informed of the financials and to meet their information requirements but in case of the small companies, generally the shareholders are in form of the promoters of the company. Therefore, the public funds are not involved and as promoters of the company, they would usually want to reduce the compliance, accounting and the legal costs and therefore would not be interested in the expending funds on getting the audit done for the company(Knechel & Salterio, 2016).
- There are a number of small companies, which form the major chunk of the European economy and United Kingdom being one of the major countries; it forms the backbone of the same. They are critical not only in terms of monetary contribution but in terms of innovation ideas and skills that they bring to the table. The exemption would lead to savings of the costs for the companies, which would have a positive impact on the results of the business, the income as well as tax collection for the economy to grow as a whole.
- Furthermore, statutory audit is something, which focuses on the compliance of accounting and legal regulation and standards. Instead of the same, the small companies could invest their funds in the improving the internal controls of the company and thereby strengthening the control and compliance, which would help the business grow multiple times and thereby achieve business goals and objectives(Kew & Stredwick, 2017).
- Exemption for the small companies would mean lesser compliance procedures and burden on them and therefore there would not be requirement of extra human resource for looking after that. Furthermore, the human resource already employed would have to devote less of time on the accounting and taxation perspective and they can focus more on research, business growth and innovation. This would help in increasing the profitability and productivity in business. This would also promote the growth of the start-up companies as they would not suffered from compliance failures when the human resource is less during the initial stages(Dichev, 2017).
Similarly, some of the arguments, which were against the audit of the small companies, are listed below:
- Off late, there compliance have increased and simultaneously the quantum of frauds have increased involving both the companies as well as the auditors. In case more companies are kept out of purview of audit, their annual accounts will be more susceptible to corporate frauds and the same may remain undetected in the absence of audit. This might also lead to erosion of trust between the owners, management and external stakeholders like those of lenders, debtors, creditors. Once the company is listed in the future, all these undetected frauds might lead to serious compliance issues and erosion of mutual trust between the shareholders and the management when the same is reported and established(Kangarluie & Aalizadeh, 2017).
- In case the audit is not done, this could lead to the erosion in the quality of the financial data of the small companies, which is available for public use. Furthermore, in case there is no regulation on what the companies are doing and how they are financially performing, it might become increasingly difficult for the banks and the financial institutions to grant loan and financial assistance, as they will be sceptical of recovery and the overall financial performance and growth of the company. This is turn might have the negative impact of increase in higher debt cost compared to lesser savings because of non-conduction of audit(Vieira, et al., 2017).
- The less of audits and clientele may also have a serious impact on the performance as well as the independence of the auditors as they would be sceptical in losing the audit and the clientele in case the true and fair opinion is given. This will only have the indirect impact on the quality of the financial reporting, the public information and the accounting and auditing profession as a whole.
- The process of conduction of audit and the setting up of the thresholds for the company is a periodic affair and therefore a lot of uncertainty and inconsistency is attached to the same. A small and growing company, which is not subject to audit in the current year, may become eligible for compulsory audit in the succeeding year because of breaching the limits and therefore the audit process becomes too complex, cumbersome and critical for the auditor, as they have to undergo the comparative analysis for the company. The increase in audit efforts would also mean increase in the audit cost for the first year and thus it is recommended that the audit should be in continuance for the growing companies once it has started(Félix, 2017).
Question: Discuss if the audit exemption threshold should continue to increase.
The question discusses on whether the audit exemption limit should be held and kept constant and held at its present limit or should be reviewed and changed year on year. As per the changing business conditions, the ideal scenario would be to have the review of the limits and the thresholds year on year as there are several factors which needs to be reviewed and studied. Some of these are:
- The business conditions and the global markets are very dynamic and keeps on changing every moment, some of these parameters include interest rate, exchange rate and the rate of inflation. The company’s assets, which are worth EUR 4 Mn as of now, may be worth more or less a year from now depending on the circumstances of the case and the government regulations, which keep on changing from time to time. Similarly, the turnover limit of EUR 8 Mn may be irrelevant from a year now considering the growth in global markets, the domestic and international demand and supply or the economic slowdown(Sithole, et al., 2017).
- There might be few companies for whom the nature of the operations might be complex and would not be easy to interpret in the absence of the expert and therefore an expert opinion from the auditor is compulsory in such cases. Therefore, even though the company qualifies the requirements of the exemption limit the same is presumed to be irrelevant in such a scenario.
- Any provision or law cannot stand the test of time and cannot stay forever as it is without modifications and changes as the business condition and the environment in which it regulates keeps on changing constantly(Appelbaum, et al., 2018). Furthermore, it is in the human nature to find out the loopholes in the laws and the provisions and to suit their activities as per their needs. To even out and stop the malpractices, the policy makers and the governance team needs to analyse, review and bring in the changes as per the circumstances of the case and to address the gaps and loopholes as and when required.
- There are other internal and external factors, which might be of significance to the country. Like for some countries, one or more of the industries is of special economic importance (e. manufacturing or service industry or aircraft or defines equipment industry) and therefore the government has a special vigilance on the performance of these companies regardless of the scale of operations and the size of turnover and assets. In such a case, the government may decide to keep such companies out of the purview of the exemption and may order compulsory audit to be conducted for the class of the companies(Dumay & Baard, 2017).
- One of the thresholds is also in respect of the employee headcount and by the use of it, many of the companies claim and enjoy the exemption benefits even when they are more machine intensive and not labour intensive. They are more dependent on the automated processes and are more technologically driven and hence it should be mandated that all such companies would be required to do audit compulsorily regardless of the number of employees. Secondly, the job scenarios are changing dynamically in the employment market and focus in more on robotics, automation and machine processes, where the number of employees is bound to be on the lower side and therefore the limit of the number of employees should be reviewed periodically and should change year on year(Lessambo, 2018).
References
Appelbaum, D., Kogan, A. & Vasarhelyi, M., 2018. Analytical procedures in external auditing: A comprehensive literature survey and framework for external audit analytics.. Journal of Accounting Literature, 40(1), pp. 83-101.
Boccia, F. & Leonardi, R., 2016. The Challenge of the Digital Economy. Markets, Taxation and Appropriate Economic Models, pp. 1-16.
Chron, 2017. five-common-features-internal-control-system-business. [Online] Available at: https://smallbusiness.chron.com/five-common-features-internal-control-system-business-430.html
Dichev, I., 2017. On the conceptual foundations of financial reporting. Accounting and Business Research, 47(6), pp. 617-632.
Dumay, J. & Baard, V., 2017. An introduction to interventionist research in accounting.. The Routledge Companion to Qualitative Accounting Research Methods, p. 265.
Félix, M., 2017. A study on the expected impact of IFRS 17 on the transparency of financial statements of insurance companies. MASTER THESIS, pp. 1-69.
Gooley, J., 2016. Principles of Australian Contract Law. Australia: Lexis Nexis.
Guragai, B., Hunt, N., Neri, M. & Taylor, E., 2017. Accounting Information Systems and Ethics Research: Review, Synthesis, and the Future. Journal of Information Systems: Summer 2017, 31(2), pp. 65-81.
Kangarluie, S. & Aalizadeh, A., 2017. ‘The expectation gap in auditing. Accounting, 3(1), pp. 19-22.
Kew, J. & Stredwick, J., 2017. Business Environment: Managing in a Strategic Context. second ed. London: Chartered Institute of Personnel and Development.
Knechel, W. & Salterio, S., 2016. Auditing:Assurance and Risk. fourth ed. New York: Routledge.
Lessambo, F., 2018. Audit Risks: Identification and Procedures. Auditing, Assurance Services, and Forensics, 3(1), pp. 183-202.
Sithole, S., Chandler, P., Abeysekera, I. & Paas, F., 2017. Benefits of guided self-management of attention on learning accounting. Journal of Educational Psychology, 109(2), p. 220.
Vieira, R., O’Dwyer, B. & Schneider, R., 2017. Aligning Strategy and Performance Management Systems. SAGE Journals, 30(1).
Werner, M., 2017. Financial process mining – Accounting data structure dependent control flow inference. International Journal of Accounting Information Systems, 25(1), pp. 57-80.
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