An 'audit bonus' for business, but dire news for small firms

OVER the last decade the audit threshold in the UK has continued to rise at a steady rate with the result being that more and more companies no longer require a formal audit.

The EU’s Accounting Directive passed earlier this year by the European Parliament proposes to further raise the threshold within the EU by a significant amount. At first glance, this would seem to be a bonus for business – but it could actually have far reaching unforeseen consequences for them, and the accounting profession.

The new directive proposes that companies with turnover of below €12m (£10m) and a balance sheet total of below €6m could be exempted from audit regulation.

Currently, in the UK, a small company which meets two out of three of the following criteria can be exempt:

• below £6.5m turnover
• balance sheet total of below £3.26m
• not more than 50 employees

While the new proposal has not yet been adopted in the UK, the Department of Business Innovation and Skills (BIS) has indicated that it will take soundings over the coming months from the accounting profession and beyond, as to whether or not to implement the proposals by the 2015 deadline.

Should this proposal be accepted, then of the 4.8 million businesses in the UK some 98%-99% of them would be potentially exempt from the statutory audit regime. This would mean that a massive majority of businesses are free from the red tape of audit regulation. Only an estimated 57,000 companies in the UK would need an audit and the majority of these companies would be clients of the larger top 30 firms.

This is great for business, but possibly only in the short term. After all, no one wishes to argue for companies to be burdened by red tape. In the longer term, however, this change could be dire for the smaller end of the accounting profession which, in turn, might have serious unintended consequences for businesses too.

The accounting profession is constantly striving to increase the quality and efficiency of the audit product it delivers and to meet the increasingly stringent requirements of this service. To achieve this, there must be continual investment in both people and systems.

The nature of the profession is that staff gain their skills by intensive formal learning and crucial on-the-job training. Once they have this, they move upward and onward and so there is a constant pressure to find quality new people to add to the staff pipeline.

This constant feeding of the staff pipeline and continual upgrading of systems is only sustainable when the ‘critical mass’ of audit work is achieved. For the model to work, both staff and systems must be fully occupied.

If the proposal of the EU Directive is implemented in the UK, we run the risk of smaller accountancy firms having to scale back their investment in their audit offering. This will inevitably mean, in time, a drop in the quality of the audit work being produced in the UK. Ultimately, there would also be the prospect that the financial statements produced will be devalued by the end users.

In addition, it could be argued that companies which currently require an audit are getting good value as there is strong competition amongst suppliers and strong downward pressure on the price of an audit. Audit fee increases amongst mid-tier firms have been relatively low over the last few years.

What we need to consider is, what happens if the smaller firms begin to drop out of the market place for audits? Will clients have fewer choices of suppliers? Will the cost of audits increase as a result? Will quality suffer? Will businesses be worse off than they currently are?

Paul Woosey is a partner and head of audit at Carter Backer Winter