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Off the hook

Businesses are likely to continue having audits despite government proposals to exempt them from mandatory requirements, finds Richard Crump

MORE THAN 100,000 small and medium enterprises (SMEs) in the UK could save in excess of £600m a year in accountancy and administration costs under government proposals to reduce financial reporting requirements.

The Department for Business Innovation and Skills (BIS) has launched a consultation on proposals to allow more small companies and group subsidiaries to decide for themselves whether or not to have a financial audit – which costs SMEs £10,000 on average – and a change in the law to allow companies to alter their accounting framework.

Current European Union rules mean that to classify as “small” for accounting purposes, a company must comply with two out of three criteria relating to their turnover, balance sheet total and number of employees. To qualify they must have no more than 50 employees, a balance sheet of no more than £3.26m and turnover not in excess of £5.6m.

However, to obtain an audit exemption in the UK, small businesses must fulfil both the balance sheet and turnover criteria. Under the new proposals, UK SMEs would be eligible for audit exemption by meeting any two of the three criteria, saving them an estimated £206m per year.

Edward Davey, the minister responsible for corporate governance, said the proposals “are aimed at removing EU gold plating and freeing up enterprise”.

But according to Phil Crooks, head of assurance at Grant Thornton, the example given by BIS about obtaining an audit exemption indicates the gold plating is actually coming from the UK.

“It is strange how the proposal is written. In the EU you only have to meet any two of the three criteria, but in the UK you have to meet two specified elements,” he tells Financial Director. “It is the UK position rather than the EU that has been more stringent.”

But Crooks and others in the audit profession were largely welcoming of the move to voluntary audit. Henry Irving, head of audit and assurance at the ICAEW, says that giving companies a choice is a good thing, but he still believes that many SMEs will continue to have an audit despite the exemption.

“An audit will enhance the credibility of financial statements that are used not just by creditors but by a variety of stakeholders,” he says. “If you are a growing business you may want to find a buyer at some point and they tend to look at the financial record over a number of years. If you have had an audit it will stand in your favour.”

Many critics have warned that traders and creditors will not deal with companies that do not have an audit, and Irving echoed this concern, saying: “It can be important to have audited accounts when pitching for contracts or seeking finance.”

The government also proposes to introduce legislation in 2012 to exempt most subsidiary companies from mandatory audit, provided the parent is prepared to guarantee their debts. Savings are estimated at £406m per year.

In total, the government says, removing this gold plating on EU rules could save UK businesses £612m a year. These moves are part of the government’s wider efforts to cut red tape and reduce unnecessary burdens on business; in particular, addressing the impact of European legislation.

Crooks says the government figure could be misleading because the savings generated by subsidiary exemptions are unlikely to reach £406m because of the obstacle of parent companies guaranteeing subsidiary debt.

“You see examples of groups chopping off subsidiaries and ring-fencing parts of the business,” he says. “Large groups will be reluctant to put that guarantee in place and will want to keep that flexibility.”

Additionally, following consultation by the UK Accounting Standards Board on changes to the UK Generally Accepted Accounting Principles (UK GAAP), the government is also seeking views on whether to allow companies that currently prepare accounts under International Financial Reporting Standards (IFRS) more flexibility to change their framework to UK GAAP.

But in practical terms a lot of businesses that have gone to IFRS have already done the hard work and are likely to be happy to carry on using IFRS rather than revert back to UK GAAP. And while the move appears inconsistent, Crook believes it may remove some of the “oddities” in the Companies Act.

“If you are on the full list and go private, you can go back to UK GAAP,” Crooks explains. “But if you are listed on AIM and go private, then you can’t.” ?

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