Small firms flourish despite drought in audit work

The revelation that nearly 90,000 small businesses have ceased to obtain an
audit for their accounts – following last year’s rise in the audit threshold
from £1m in annual turnover to £5.6m – may have come as a shock to government
and business.

After all, it was anticipated that only an additional 69,000 companies would
fall under the level at which audits become mandatory, and that many of these
would still hire auditors.

But with research from credit information agency Graydon showing that an
additional 20,000 companies have avoided an audit, it is clear the government
has underestimated both the number of SMEs affected and their willingness to
voluntarily audit their accounts.

Graydon predicts that, with the average SME audit costing around £4,000, some
£360m of fees are being lost to the UK’s small accountancy firms.

‘When the audit exemption first went up, we took the view that quite a number
of clients would want to carry on having an audit, even though they didn’t
technically need to have one for reassurance,’ says Eric Kench, partner at small
firm E A Kench & Co and chairman of the ICAEW’s practice society.

‘Now, I can only think of one of our clients who actually decided that it
would continue with an audit. Everybody else says if they don’t need one then
they’re not going to have one.’

However Peter Mitchell, chairman of the Society of Professional Accountants,
believes the government’s initial estimate of the number of companies
voluntarily taking on an audit was overly optimistic.

‘For most very small privately owned companies, the audit doesn’t produce
anything by way of a tangible benefit, and therefore they would be pleased to
see it go,’ he argues.

But fortunately, both agree that the change does not seem to have caused too
many headaches for smaller accountancy firms. Even though the amount of audit
work has gone down, some seem genuinely pleased by the move.

‘Largely we were providing the audit service as a loss leader on top of other
accounting services. Now time has been freed up, we are able to apply it more
meaningfully to the client, and profitably to us,’ says Mitchell.

‘Smaller firms are just breathing a huge sigh of relief that they no longer
have to do audit, and they can actually get on and do things their clients want
more,’ adds Kench.

Clients often have fixed budgets and money spent on an audit may go on
something else instead, he argues.

Smaller companies that do want to continue with an audit may get a shock when
they receive their new quote for work. ‘Where we are retaining the audit, that
audit is becoming increasingly expensive for the client,’ says Kench. The reason
is that his firm is taking on a much bigger risk for clients who require an
audit than for those that do not. ‘Therefore we should be charging quite a lot
more for the audit reassurance they are getting.’

Despite the removal of a legal requirement for companies with an annual
turnover of less than £5.6m, there are still cases where an audit will be
needed. Banks, for instance, usually ask for audited accounts when businesses
approach them with requests for significant extra credit.

As smaller firms cease to carry out audits, the SPA anticipates
specialisation will occur with the establishment of ‘mini-audit specialists’
that provide firms with the necessary expertise and the required auditing
certification for the rare times that a client does want an audit.

Further down the line, banks may even decide to drop the audit requirement
for smaller companies. The Professional Oversight Board for Accountancy, along
with the ICAEW, is currently studying the financial reporting needs of small
businesses, the results of which are expected in the next few weeks.

Part of this study will look at whether some kind of assurance service that
would cater for smaller companies would be appropriate. Banks, it seems, might
favour this approach.

‘Accountants are working on producing assurance reports and that’s fine,
that’s helpful,’ says Stewart Dickey, director of policy for SMEs at the British
Bankers Association. ‘As long as they can be produced in a timely fashion then
they will be useful.’

Whether such a system will come to be depends largely on POBA, but it remains
to be seen how enthusiastic companies will be for such services.

Related reading