Audit exemption 'unlikely' to save £600m

MORE THAN 100,000 small businesses 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 subsidiaries to decide for themselves whether to have a financial audit – which costs £10,000 on average for a SME – and allow companies to change their accounting framework.

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

However, small businesses must fulfil both the balance sheet and turnover criteria to obtain an audit exemption in the UK. Under the new proposals, UK SMEs will be eligible for audit exemption by meeting any two of the three criteria, saving 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 the example given by BIS about obtaining an audit exemption indicates that the gold plating is actually coming from the UK, according to Phil Crooks, head of assurance at Grant Thornton.

“It is strange how the proposal is written. In the EU, you only have to meet any two out of the three criteria, but in the UK you have to meet two specified elements,” he told 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, said that giving companies a choice is a good thing, but still believed 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 said. “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 warned 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 has also proposed to introduce legislation in 2012 to exempt most subsidiary companies from mandatory audit, provided the parent is prepared to guarantee debts. Savings are estimated at £406m per year.

The government said that removing this gold plating on EU rules could save UK businesses £612m a year in total. These moves are part of the government’s wider efforts of cutting red tape and reducing unnecessary burdens on business, in particular addressing the impact of European legislation.

Crooks said the government figure may be misleading as the savings generated by subsidiary exemptions are unlikely to reach £406m. The obstacle of parent companies guaranteeing subsidiary debt will be difficult to get around.

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

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 to UK GAAP. While the move appears inconsistent, Crook believed 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, but if you listed on AIM and go private, you can’t,” said Crooks.