The arguments for and against having an audit

Introduction

For financial years ending after 30th March 2004, a company is no longer compelled to have an audit, if its turnover does not exceed £5.6m and its gross assets do not exceed £2.8m. The previous turnover limit had been £1m, which was effective from July 2000. After this latter ceiling was put in place, 60% of the relevant companies discontinued having an audit. The increased level will result in approximately 69,000 companies no longer being obliged to have an audit.

However, according to the DTI, 85% of private companies still have their financial accounts professionally prepared by firms of accountants. This is because there has been no relaxation in the technicality of the format and content of accounts required by company legislation. Very few companies have the internal resources to complete their year-end accounts fully and accurately.

So what are the reasons to take advantage of the Government's relaxation of the rules and what are the perceived disadvantages of foregoing an audit?

Reasons to keep the audit

Some of the reasons for continuing to have an audit will be as follow: -

  • Shareholder reassurance. This is particularly relevant where there are shareholders who do not work in the business or, in the case of working shareholders, with minority holdings. Shareholders who hold not less than 10% of any class of the company's share capital can require a company to obtain an audit of its accounts for a particular year.
  • To reduce the likelihood of fraud. Whilst the audit cannot guarantee to pick up all errors, it is often seen as a deterrent to fraud, as staff know that the figures are going to be scrutinised externally
  • The comfort and quality factor. For many companies, an audit report, signed by a respected firm of accountants, adds credibility and a mark of quality to the company and its accounts.
  • The requirements of lenders and venture capitalists. It may be a condition of an advance that audited accounts are made available. However, research from the Society of Professional Accountants, following the increase in the threshold from £350k to £1m found hardly any evidence that unaudited companies found difficulty in raising finance. Nevertheless, for companies in the turnover range of £1m to £5.6m, this may not prove to be the case.
  • Planning to sell. It could add to the substance of a company, if its accounts are audited, particularly in the last few years leading up to a sale. This will depend on the size of the company.
  • To remove concerns that not having an audit may have a negative effect on the company's credit rating.

Choosing to dispense with an audit

  • First and foremost, a valid reason is to reduce costs. A significant proportion of an audit fee relates to the need for the auditor to cover his own compliance costs. Auditing is heavily regulated. Audit firms receive periodic visits from members of their professional body's monitoring team, who will inspect a selection of files.
  • The firm's licence to audit may be withdrawn if its files are not comprehensive. This, of course, means that significant time has to be spent in making sure that audit files would pass an inspection.
  • A saving of around £2,000 would be achieved if the audit element of a £5,000 fee, covering both audit and accounts preparation work, were removed.
  • Management time will be freed up by not having to prepare for the annual audit and deal with the auditors' queries.
  • The saving from not having an audit can be applied to value-added advice from the accountants, such as industrial benchmarking, corporate strategy and business planning.
  • Since April 2004, Chartered Accountants can include a new form of report called a Compilation Report. Chartered Accountants are required by their Institute to carry out their work in compiling statutory accounts, with professional competence and due care. The Compilation Report, the cost of which will be more much more economical than an audit, will confirm that the firm has complied with this requirement. This confirmation will therefore add credibility to the accounts, even though an audit has not been performed.
  • Certainly, in view of the complexity of statutory accounts and the need for complete accuracy, an unqualified accountant should rarely be entrusted with the responsibility for their preparation.
  • Some concerns have been expressed that there is a greater likelihood of Inland Revenue or VAT investigations, if a company submits unaudited accounts. However, since the time when audits, for low turnover companies, first became voluntary, there is no evidence that this is the case.
  • The reason for this is, as mentioned above, that very few small companies prepare and submit their own accounts. Their accountants deal with this for them. This is no different to the situation with the accounts of unincorporated businesses, whose accounts are prepared by accountants, before they submit them to the Inland Revenue. Rarely are these audited.

For those companies wishing to continue to have annual audits, the key to cost saving is advance preparation, so that the amount of work to be carried out is kept to a minimum.

Michael Warner and Company can advise you in this respect, as, although we have made a strategic decision not to carry out audits, we have many years' prior experience of auditing. We can guide you in the preparation of a comprehensive audit file to present to your auditors, and assist you to foresee any questions and requests for further information they may raise. We can also negotiate the audit fee on your behalf.

An alternative to a formal audit

If shareholders decide that a formal full audit is not necessary, it may nevertheless make sense for tailored checks to be requested from their accountants. For example, it is usually very beneficial for periodic Business Health Checks and Risk Assessments to be carried out. An independent eye cast over the financial systems and procedures can often detect weaknesses.

Apart from the need to prepare annual accounts to satisfy the needs of Government departments, they often have little use or value. They are not used for management purposes, except to aid trend analysis.

The only accounts of any real value are the monthly management accounts, which are produced for decision-making purposes, and compared against budgets. The quality of modern accounting software, produced by companies, such as Sage and Pegasus, is now so very high, that, in the appropriately trained hands, accurate accounts can be prepared for all 12 months of a year, not just for the 12th month, the "audit month".

Conclusion

For many, an audit is an expensive and unnecessary imposition, providing little of value. For others, it can represent, amongst other things, a valuable form of quality assurance, backed by the Professional Indemnity Insurance of the auditors.

The key question to ask yourself is "if an audit had never been available before and were now to be offered to me, with the benefits being fully explained and understood, would I voluntarily invest in one?"

In our opinion, the decision should usually be to dispense with the audit. The cost saved can then be much more effectively used in obtaining advice to achieve increased profits and capital value.

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