Directors view on exemption audit.

Essay by SpyMike February 2006

download word file, 3 pages 5.0

INTRODUCTION

This study was commissioned by the Department of Trade and Industry (DTI) in February 2003 and supports the government's stance on evidence-based policy making. The aim of the research is to investigate issues in connection with audit exemption by examining the views of the directors of private limited companies that fall within the European Community size thresholds for a small entity. The main issues investigated are take-up levels of audit exemption, cost savings and the factors that have a significant influence on the directors' decision regarding a voluntary audit if thresholds in the UK were raised to the EC maxima. At the time of the study these were turnover £4.8m, balance sheet total £2.4m and number of employees 50.

The research was designed as a large-scale postal questionnaire survey, preceded by a small number of preliminary interviews with auditors and small company directors to develop the questionnaire.

The study provides evidence that size is not a sufficient measure on its own for capturing the costs and benefits of the audit.

There are other qualitative factors that have a significant influence on the directors' decision on whether or not the accounts will be audited on a voluntary basis.

THE SURVEY

The study is based on the analysis of 790 postal questionnaires received from a population of 2,633 active, independent, unlisted, private limited companies filing full accounts. This represents a response rate of 30%. The companies were selected on the basis of their 2002 accounts providing figures that showed that they had a maximum turnover of £4.8m, maximum balance sheet total of £2.4m and up to 50 employees. (EC Maxima Standards)

LIMITATIONS OF THE SURVEY

The selection of companies on the basis of turnover was essential, as this is the key measure of size for audit exemption in the UK. However, it means that the sample consisted of companies filing full accounts and one limitation of the study is that companies filing short accounts were not consulted.

THE SAMPLE COMPANIES

In 94% of cases the questionnaire was answered by the principal director, finance director or company secretary. The position and educational profile of the respondents suggested they would have both tacit and formal knowledge with which to answer the questions and weigh up the costs and benefits of the audit when making the audit decision.

THE RESULTS OF THE SURVEY

Although 31% employ a qualified accountant in a financial role in the business, it would appear that accounts preparation is usually outsourced, as in 85% of companies an external accountant prepares the statutory accounts.

Using a maximum turnover of £2.8m as a proxy for eligibility, 67% of respondents reported that their 2002 accounts had been prepared using the Financial Reporting Standard for Smaller Entities (FRSSE). This provides important evidence on the take-up of the particular aspect of generally accepted accounting principles for Smaller Entities (GAAP).

Using a maximum turnover of £1m as a proxy for eligibility, 58% of the sample took up audit exemption in their 2002 accounts compared with 42% who filed audited accounts.

The main reason for filing unaudited accounts in 2002 was lower accountancy fees, but very few directors were able to report the specific amount saved. Of those that did provide a figure, the typical reduction was £1,000. This seems valid, as it matches the typical fee disclosed in the 2002 accounts. The fact that so few directors reported any savings from discontinuing the audit implies that it may not have been a significant saving or that it was offset by other charges.

INFLUENCES ON THE VOLUNTARY AUDIT DECISION

The results of further analysis of the factors that have a significant influence on the audit decision using logistic regression reveal the directors are more likely to have a voluntary audit if the company has the following characteristics: 1. It is larger in terms of turnover and 2. the directors consider that the audit improves the quality of the financial information, 3. has a positive effect on the credit rating score 4. provides a check on accounting records and systems; 5. it is not wholly family-owned 6. has shareholders without access to internal financial information;.

IMPLICATIONS OF THE FINDINGS

The findings of this study can be generalised to other active, independent, private limited companies filling full accounts with a maximum turnover of £4.8m and balance sheet total up to £2.4m. They should be of interest to the regulators, the accountancy profession, those who advise small companies and academics, as well as the owners and directors of small companies themselves.

CONCLUSIONS

The findings of this study provide evidence that size is not a sufficient measure on its own for capturing the costs and benefits of the audit. There are other qualitative factors. If thresholds are raised to European Community levels, policy makers should be aware that the new category of small companies would contain two subgroups with different needs. This heterogeneity should also be taken into account by those who contribute to the development of differential reporting on the basis of size at the international level.