History And Changes Of Audit Exemption Thresholds In The European Union And UK

Audit Exemption History in the European Union

As per the resolution passed by the European Parliament in June 2013, broadly entities apart from public interest entities (which is basically those entities whose securities are widely traded in the stock market, lending institutions, insurance providers and any other entity which has been specifically named as such by any of the member countries of the European Union) and medium sized or large undertakings, are not mandated to have their statutory audit done (Axelsen, et al., 2017). This essentially meant that all those companies, which fall under the stated definition of small undertakings, will be exempted from the requirement of statutory audit. There have been thresholds provided as to which are the companies that can be classified as such. A comparative analysis of the thresholds shows that the limits for both balance sheet total and net turnover have been lowered with respected to the figures that were stated in the 2011 and the 2006 amendments. A company to be categorized as a ‘small undertaking’ needs to fulfil at least two out of the three thresholds. Their balance sheet total must not exceed 4 million Euros, Net Turnover shall not exceed 8 million, or average number of employees on the payroll of the companies during the financial year shall not exceed 50 employees. However, owing to the peculiarities in each of the member countries, they have been an option to increase the stated threshold to some extent, which in any case shall not exceed 6 million euros for balance sheet total, and 12 million in case of turnover of the companies. In addition to the above allowable variance, there is also a permissible variation of 5 percent for exchange rate fluctuations between Euro and local currency of the member countries (Belton, 2017).

Despite the provision of permitting increase in thresholds, only one third of the member countries chose to exercise this and increase the limit. This goes to show the increased levels of trust and reliance, the policy makers put on the role of the statutory auditors. They recognize the fact that audit is an important aspect in regulating the economy and safeguarding the value of the stakeholders. It is pertinent to note that it is up to the small undertakings to choose if they want to get themselves audited, i.e., they may voluntarily decide to get statutory audit done (Alexander, 2016).

In case of UK, the thresholds limits are a little higher than the stipulated thresholds. The categories of companies to be qualified as small companies are like those of ‘small undertakings’ classification in the European context. However, in the UK scenario a lot of emphasis is laid out on the definition of companies that form part of a group of companies to be eligible as small companies’ exemption. The regulations in the UK states that those subsidiary companies which may or may not be part of a ‘small group of companies’, if it meets all the conditions laid down under section 479A and does not fall under the classification of companies mentioned under section 479B is also exempt from the mandatory provisions of statutory audit. In case of UK, it is interesting to observe that UK falls under those one-third of European Union members who have increased the threshold limits for balance sheet total and turnover total for small company classification. The increase is significant in percentage when represented in terms of British pounds. Prima facie, this move by the UK lawmakers aims to benefit a large of chunk of companies by savings in audit costs, which may become a burden for some of them and would boost the index ranking of the country in terms of ‘ease of doing business’ (Bumgarner & Vasarhelyi, 2018).

1. a) Small businesses form the backbone of the European economy including the United Kingdom. Not only in monetary terms but also in terms of innovation, ideas and entrepreneurial skills, small companies have a lot to offer to the European economy. Savings in audit costs to each of them would have a dramatic impact in terms of absolute financial terms. This in turn could flow back into the economy thereby aiding the income and the taxes paid(Choy, 2018).
2. b) If the small companies have a lesser compliance burden on them, it would be easier and more efficient for them to manage their workload. If the human resources available to them are less devoted to accounting perfection and more towards business growth, research, innovation and marketing, they could deliver improved performances with perhaps the same number of labour. Lower compliance burden would also mean lower chances of default in compliance. This becomes increasingly relevant in start-up companies, which have their human resources stretched in the initial stages and may sometimes, is entangled into compliance failures(Bizfluent, 2017).
3. c) One of the principal audience of the audit reports are the shareholders of the companies. In case of small companies, it is generally seen that the shareholders are mostly the promoters of the business. In other words, public funds are usually not involved largely. Therefore, in case the promoters themselves are the shareholders of the company, they would make every possible effort to reduce the costs of the company and thus avoiding audit costs (Linden & Freeman, 2017).
4. d) In place of a statutory audit, which lays its focus mostly from an accounting regulation point of view, the smaller companies could put their resources both financial and human towards stretching the internal controls, which could provide better results in strengthening the control environment of the small businesses, which ultimately boosts their ability to achieve growth targets.

1. a) The absence of an audit may lead to a fall in the quality of the financial data of companies that are available in the public domain. This could be major reason for the companies who despite having the benefit of exemption notification, refrain from exercising the option and chose audit. Without a third party independent view on the financials. It would become increasingly difficult for banks and other financial lending institutions to aid them and they would be worried about the recoverability and financial health of the companies. This would practically erode the financial gains from not conducting audit by offsetting it with the higher debt costs(Goldmann, 2016).
2. b) The other demerit of choosing audit exemption is the uncertainty and inconsistency attached to it. The thresholds for the audit are to be evaluated each year. This would mean that small businesses which are constantly growing might be exempt from the audit requirement for a few years but they may again breach the threshold limit a few later and would then be again mandated to get the statutory audit done. So, for the auditors, the job becomes cumbersome for the first year in which they start auditing again as they will also have to channelize their focus on comparative figures as well. As the efforts of the auditors, increase so will be the cost associated with the audit for the first year. It is thus more in the interest of growing companies to continue having their audit done.
3. c) Keeping more and more entities out of the purview of audit will make the transactions and dealings of those entities more susceptible to fraud, which has highly possibilities of going undetected. This would create a trust deficit between the owners of the business and other parties who might be associated with the company such as creditors or lenders. Since a fraud might go undetected for years and may continue to exist, it would catapult into a major issue when the company later applies to be a listed entity because then there will be involvement of the public money as well and could seriously jolt the mutual trust if any misdeeds are reported at a later stage(Sonu, et al., 2017).
4. d) From a more psychological point of view, the audit exemption thresholds or its enhancements is also likely to hit the auditor’s community very hard. The morale of the audit community will take a hit because of the declining clientele. If they have lower number of clients, it may indirectly hamper the degree of independence they would exercise in giving professional opinions on financial statements of the entities they audit. They might fear a backlash of losing audits from resentful clients. Such pressure will not do well the professions as well as the quality of financial that are required to be maintained.

Audit Exemption Threshold Changes in the European Union and UK

The focus of the above point revolves around whether the audit exemption should be held at its current level or there needs to be a periodic review of it. In my opinion, the ideal scenario would be doing deal with each year separately and carry out a review of the threshold limits on a year-to-year basis. Many factors will put credibility to this argument.

Firstly, the global markets are very dynamic and are shaping every minute. The changing pace of inflation, exchange rates and interest rates act as catalyst to the overall change in dynamics. Assets worth of 4 million euros now may be worth more or less one year down the line depending on the above variants involved and due to changes in government regulations such as custom tariffs, subsidies etc. Similarly, 8 million euros of turnover today may become totally different next year if there is a pick-up in domestic and global demand or a slowdown in the economy instead (Raiborn, et al., 2016).

Secondly, other factors might be of relevance apart from purely the numbers. For instance, there could be case where an industry is of more strategic importance than the other such as manufacturing of defence equipment or drug manufacturing. The government may want to keep a close watch on the financials of these entities regardless of their scale of operations for various other reasons. In that case, they may decide to keep it out of the purview of the thresholds limits and put it under the mandatory class of companies for which statutory audit is required (Kachelmeier, et al., 2018).

Thirdly, there might be some entities which might be covered under the threshold limits but the nature of their operations is such that makes the financial operations more complex for the users of the financial statements difficult to interpret. An expert opinion, like that of the auditor, may be required in such cases which would help the users to get a better picture of the performance of the company. Therefore, in such circumstances the monetary ceilings of balance sheet total and turnover are of not much significance.

Fourthly, there needs to be a review of number of threshold employees each year. This primarily because of two factors. One can be attributed to the fact that there might be certain kinds of business models that may not be labour intensive. They might have a significant degree of dependence on automated processes but by using the provisions, they are falling outside the purview of mandatory statutory audit. In technologically driven companies, there is significant requirement of audit of to be done regardless of the employee headcount. The other possible reason is the ever-changing job scenarios in the global and domestic employment market. Due to constant technology upgradation, innovation and amendments in labour laws, the threshold on number of employees cannot be kept constant and should be subjected to reviews on an annual basis (Fukukawa & Mock, 2011).

Lastly, it is rarely seen that the law, rules or regulations will stay as it was framed originally without modifications and alterations in line with the environmental changes in which it regulates. It is a human nature that they will find out ways to circumvent or adjust the laws to suit their needs by analysing the loopholes or possible gaps in the provisions. To counter these measures, the policy makers are bound to act accordingly and review the law after specific periods of time to address these gaps and cater to any issues or hardship that might arise unknowingly because of the provisions.

References:

Alexander, F., 2016. The Changing Face of Accountability. The Journal of Higher Education, 71(4), pp. 411-431.

Axelsen, M., Green, P. & Ridley, G., 2017. Explaining the information systems auditor role in the public sector financial audit. International Journal of Accounting Information Systems, 24(1), pp. 15-31.

Belton, P., 2017. Competitive Strategy: Creating and Sustaining Superior Performance. London: Macat International ltd.

Bizfluent, 2017. Advantages & Disadvantages of Internal Control. [Online]
Available at: https://bizfluent.com/info-8064250-advantages-disadvantages-internal-control.html
[Accessed 07 december 2017].

Bumgarner, N. & Vasarhelyi, M., 2018. Continuous auditing—a new view.. Continuous Auditing: Theory and Application, 20(1), pp. 7-51.

Choy, Y. K., 2018. Cost-benefit Analysis, Values, Wellbeing and Ethics: An Indigenous Worldview Analysis. Ecological Economics, p. 145.

Fukukawa, H. & Mock, T., 2011. Audit risk assessments using belief versus probability. Auditing: A Journal of Practice & Theory, 30(1), pp. 75-99.

Goldmann, K., 2016. Financial Liquidity and Profitability Management in Practice of Polish Business. Financial Environment and Business Development, 4(3), pp. 103-112.

Kachelmeier, S., Schmidt, J. & Valentine, K., 2018. The disclaimer effect of disclosing critical audit matters in the auditor’s report. SSRN, 2(1), pp. 1-39.

Linden, B. & Freeman, R., 2017. Profit and Other Values: Thick Evaluation in Decision Making. Business Ethics Quarterly, 27(3), pp. 353-379.

Raiborn, C., Butler, J. & Martin, K., 2016. The internal audit function: A prerequisite for Good Governance. Journal of Corporate Accounting and Finance, 28(2), pp. 10-21.

Sonu, C., Ahn, H. & Choi, A., 2017. Audit fee pressure and audit risk: evidence from the financial crisis of 2008. Asia-Pacific Journal of Accounting & Economics , 24(1-2), pp. 127-144.