You No Longer Qualify For An Audit…But Should You Still Have One?

Matt Leggett, Lovewell Blake LLP

As you may have heard, recent Government announcements have aligned the rules for audit exemption with those for small company qualification.  These changes come into effect for accounting periods ending on or after 1 October 2012.

The detailed rules are quite complex, but generally to qualify for audit exemption the company must satisfy at least two out of the following three criteria – in either the current or previous year:

• Turnover not more than £6.5m per annum
• Balance sheet ‘gross assets’ not more than £3.26m
• Not more than 50 employees

Furthermore, should the company be a subsidiary of a larger parent and qualify under the rules above, then exemption is also available should the parent company guarantee all of the debt of the subsidiary.

I don’t feel, however, that a simple set of criteria is enough on its own to determine whether a business ‘needs’ an audit.

Big Sales Limited

Your company has, let’s say, turnover of £7.8m, but leases its premises, has decent credit control and does not retain much cash in the business. The chances are, under the present rules, you were only having your accounts audited by triggering the turnover clause, so exemption from audit is likely to be an option going forward.

On the surface it could actually save the company money by reducing compliance costs. “This sounds like a good idea.” I hear you say. To understand if the audit adds value consideration must be given to what goes on beneath the exterior of a statutory audit.

I doubt there are many people who would say that a business with turnover of £7.8m is a “small” company. In the eyes of the owner manager, it probably appears fairly large and has taken significant sacrifice to get to where it is. In which case, the owner manager probably has a few other managers and staff to help him or her run that business.

In order for this to work effectively for the good of the business, controls and procedures must be put in place to ensure everyone is pulling in the same direction and problems can be identified quickly.

What is probably unnoticed about audit work is the time spent reviewing systems and testing that controls and procedures are still working as they should. Each year the auditor is required to report back to you any weaknesses and problems we have identified. Without an external audit, who is going to take on this responsibility?

Small Subsidiary Limited

You currently have a small subsidiary, which is part of a much larger group. In the past an audit had to be carried out, but not any longer. As long as the parent company guarantees all of the debts of the subsidiary you don’t need one.

This is an interesting debate. Why did you create the subsidiary in the first place? In many cases a venture into a new product, market or geographical area is fraught with danger. A separate company somewhat protects the existing business from such risks.

Having a trade in a separate limited company limits the risk of financial loss to just that entity, this is the concept of “limited liability”. But to guarantee the debts of such a subsidiary is potentially increasing that risk for the rest of the group.

Should some unforeseen event happen to the subsidiary, which results in damaging legal claims, product recalls or some other costly issue, the potential expense would no longer be limited to just that company. The parent could also be liable under the guarantee arrangement. We have seen many times that just by being small you are not exempt from large claims. Does your parent company want to take on that risk, just to save compliance costs?

A breakdown in systems or controls can potentially be devastating to any business, so please consider the business’s long term needs before making your decision. In situations similar to the ones above, the ultimate question must be: Can I afford not to have an audit?

There are many different types of businesses in between these examples so it is not necessarily a simple decision to make, and should never be based upon cost savings alone.

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