Audit Exemption in the EU: Arguments, Thresholds, and Business Impacts

This report delves into the topic of audit exemption within the European Union, outlining the benefits and drawbacks of exempting small companies from mandatory audits. It begins by explaining the EU's audit exemption framework, referencing relevant directives and thresholds. The report then presents a detailed analysis of arguments both in favor of and against audit exemption, considering factors like cost savings, reduced workload for businesses, potential for fraud, and complexity for tax authorities. Furthermore, the report explores the consequences of increasing audit exemption thresholds, including the potential loss of auditors, impacts on profitability, and the risk of unfair trade practices. The analysis emphasizes the importance of balancing the needs of small businesses with the integrity of financial reporting and the protection of stakeholders. The report concludes by emphasizing the need to carefully consider the implications of any changes to audit exemption thresholds to ensure the stability and fairness of the financial system.

AUDITING

Table of Contents
1 Audit exemption in the European Union ..............................................................................1
2 Arguments in favour and against regarding audit exemption for small companies ...............3
3 If the audit exemption threshold continue to increase.............................................................6
REFERENCES................................................................................................................................8

1 Audit exemption in the European Union
The European Union had achieved the benefit of audit exemption for small companies. In
order to motivate the directors of small or private companies made voluntarily demand audit
assurance after analysing the sufficiency of turnover of the small or private company. No doubt
that the small functions are the backbone of European economy because its a main source of
Ideas, Innovations, Entrepreneurial skills, inventions and also its a main source of new
Employment creation for Large companies. The expansion of micro, small and medium sized
businesses increases from the recession of 1980's, since that time there is huge increment in
number of employments or opportunities for the new employees, not only this it was the
beginning of sole proprietorship and partnership businesses.(Caramanis, 1999)
Accordance with the fourth Company Law Directive, article 51 all limited companies are
required to have annual account audited, but article 11 the option to exempt small companies.
small company is one that for two consecutive years does not exceed any two of three size
thresholds. The term 'thresholds' are subject to periodic revision by the European commission for
the indexation purposes.( Francis, 1984) Although, this act ensures the small, medium sized
companies and limited liability partnership qualified for the audit exemption, are not explicitly
required to have an audit but the member states can impose an audit on small companies, audit
must regarding to appropriate for conditions and needs of these companies and the users of their
accounts. Several acts of European parliament and and council regarding the auditing and its
terms or regulations, states that Public interest entities(companies which are traded ton regulated
market, credit and insurance institutions etc) and medium sized and large companies, periodic
audit of accounts is mandatory for these companies because they operates at large scale and
traded with other nations also so that is why to avoiding fraud it is necessary or mandatory (made
by European parliament) for them to have periodic auditing. For small undertakings are
mandatory required to have periodic audit and recital 43 of Accounting Directive defines that
this was the intention.
Article 3(2) of the Accounting Directive defines small undertakings, imposed some
regulations regarding balance total limit is 400000€, net turner limit is 800000€ of particular
accounting period, and average number of employees limit is 50 during the accounting year,
must not exceeds the limits. But member states are permitted to increase the thresholds, the
1

limits can be increase up to in context of balance sheet total exceed limit is 600000€ , and net
turnover limit is 1200000€ of particular period of time.
For example, since many year in UK all the limited organisations, no matter of size, were
required to make independent audit. Auditing of annual accounts is crucial as the
annual accounts determines the completeness, accuracy and validity of transactions of business,
when complete make up the financial statements. Although, the audit
regulation ensures the difficulties of attempting to enforce one set of rules regarding the
auditing of medium and large companies prevailing in a widely
diverse market. In 1994 this state of
universality was changed when provisions permitted under EU law to exempt small
companies from the statutory periodic audit were first adopted in the UK. United Kingdom is
one of the country that recently adopted the EU maxima for determining a small company for the
purpose of audit exemption. Overall, now in UK also it is benefit for micro and small
companies, as they free from the periodic auditing of accounts.
2

2 Arguments in favour and against regarding audit exemption for small companies
Arguments against of audit exemption for small companies:
 Audit exemption leads to complexity in financial reporting: No doubt in this
statement that the audit exemption leads to complexity in financial reporting framework,
as due to exemption from periodic auditing of small companies results in improper
reporting of financial reports, although that a rise was needed to adjust for inflation and
results in increasing number of frauds and scams in annual report as due to this it creates
problem for small potential investors also. Although, this will leads to increment in risks
of poor financial reporting as it may pertain violation of accounting standard while
preparing the final statements. (Rezaee, 2004.)
 Audit exemption leads to increase in risk or frauds and scams: This statement is also
fully correct that audit exemption for small companies results in poor financial reporting
which leads to increase in frauds and scams with large unaudited businesses potentially
hiding criminals or even terrorists activity.(Willett and De Beelde, 2002) Moreover, due
to poor financial reporting it results in fake data and it becomes impossible to know the
exact profitability or losses of the business. Removing the statutory audit requirement
doesn’t necessarily lead to a wholesale risk of fraud among these businesses. So that is
why it leads to increment in cases of fraud and scams in businesses.
 Audit exemption leads to complexity for Tax authorities: Nothing is wrong in saying
the above statement that audit exemption leads to complexity for tax authorities, as due to
poor financial reporting it becomes a complex matter to calculate the exact amount of
income earned by the small undertakings for the calculation of correct amount of tax
chargeable from these undertakings. Overall the financial statements are use to give true
and fair information about the company's performance. But after exemptions, the final
statements of small undertakings pertain errors and fake information regarding the profit
of the company so that is why it leads to complexity for tax authorities.(Dedoulis and
Caramanis, 2007)
 Audit exemption ensures decline in confidence of external parties: It is true that the
audit exemption leads to decline in confidence of external parties, as an audited financial
statements provides more credibility than a non audited financial statements. This builds
3

confidence external parties like of lenders, suppliers and potential clients, investors etc.
in the business line of company.
Arguments in favour of audit exemption for small companies:
 Audit exemption beneficial in saving of time and cost: Nothing is wrong in this
statement that exemption from auditing is beneficial in saving company's time and
money. Auditing costs are relatively expensive and also a very lengthy procedure so it
consumes both time and money of organisations. Exemption of auditing helps in saving
the high fees of auditing this contributes to revenue maximisation of entity and also saves
the time of entity and ensures the entity to focus on the business operations and future
plans. (Elliott and Willingham, 1980)
 Audit exemption beneficial in Harassment of staves: As the employees are not able to
express their own terms of auditing, these all changes are serialized and the employees of
the organisation fell harassed due to changes that are made due to audit. Even if the
employees tries to represent their ideas, the organisation may not support or entertain the
employees in these types of conditions.
 Audit exemption removes the extra work burden: Small scale industries may usually
proceed with transactions that are usually completed within the short time period and less
number of transactions so that is why auditing is not too important for small scale
industries. Although, the auditing involves very lengthy procedures and requires to
follow the lengthy accounting process of recording transactions but it is not necessary for
micro or small sized industries thus exemption of auditing helps in reducing the burden of
work.
 Audit exemption helpful in tax saving: it is true that the audit exemption helps the
small scale industries in saving of some tax amount, as poor financial reporting system
hide the actual income of the organisation and shows the fake data this leads to improper
calculation of tax amount and become benefit for small scale industries. The
unsystematic financial reporting helps in hiding the real earnings of the entity and
overstatement of expenses reduces the amount of profits mentioned in final statements,
this all helps in hiding income from tax authorities and tax authorities fails in calculating
the real amount of tax.
4

 Audit exemption helps in wealth increment: It is true that Audit exemption is helpful
in wealth increment of small organisations, as due to unfair financial statements helps in
hiding the actual earnings and profits of the entity from the tax authorities not only this
saving of audit fees of periodic auditing, these all helps in increasing the wealth of entity.
5

3 If the audit exemption threshold continue to increase
If the audit exemption threshold continue to increase then it ensures bad impact on the
business as well as financial sectors. As due to increase in thresholds will leads to some affects
which are as follows:
 Loss of auditors: If the audit exemption thresholds continue to increase then more small
companies may make use of the services of professional accountants (audit firm or CAs)
on a voluntarily basis. It is therefore important that the profession
determines the importance of audit and assurance services for small businesses, as for few of
them the value
of such services may not be quickly perceived. Overall, this will results in unsystematic way of
audit and assurance and also gives bad impacts profession of audit and assurance.
 Affects the profitability: No doubt in this statement that improper format of preparing
and reporting of financial statements, not helps in ascertainment of profit and will
increase in number of scams of funds in organisation as due to poor financial reporting
system. It affects the profits of the organisation and also affects the entire financial
position of the business. Overall the ascertainment of profit is the desired objective of
each organisation but it can't be possible with the Poor financial reporting system.
 Unfair increment in number of small businesses: If the exemption thresholds continue
to increase then it will results in unfair increment in number of small businesses as
because it promote the unfair trade practices and fraud regards with tax savings this all
gain the attention of people to engaged in small businesses and overall this will affect the
earnings of medium and large sized organisations. Not only this, poor financial reporting
system and increase in threshold's limits will results in increasing number of medium
sized companies registers themselves by the name small businesses entities.
 Increment in audit exemption thresholds results in increase in risk or frauds and
scams: The exemption leads to the main drawback that is poor financial reporting, which
results in increasing cases of frauds and scams within the organisation and large
unaudited businesses potentially hiding criminals or even terrorists activity. Moreover,
due to poor financial reporting it will leads to presentation of fake data and it becomes
impossible to know the exact profitability or losses of the business. Increasing in
thresholds limits will the and removing the statutory audit requirement give bad impact
6

in form of increment of risk of fraud among these businesses. So that's why, it leads to
increment in cases of fraud and scams in businesses.
 Unfair trade practices with investors: If the audit exemption threshold limits are
continuously increases then the small organisations will operates at large scale; large in
context of capital, turnover and balance sheet total amount and this will attracts the
interests of investors and poor financial reporting system help the organisations unfairly
hide the profits of the business and this will destructs the interest of investors, so from
investors point of view it will not acceptable.(Munir Sidani, 2007)
So, on the basis of above points it is clear that audit exemption thresholds limits must not
be increases as it will not good for people, investors, other medium sized organisations, for
government and tax authorities. This will violates the accounting standards and also increase the
chances of frauds.
CONCLUSION
From the above study it has been concluded that the exemption of auditing is beneficial
for small entities and for audit firms also. The audit exemption thresholds limits must not be
increases, as it has many bad impacts on the business environment. Overall it is better for the
business and its environment to set up thresholds limits and remains the micro and small entity
free from auditing.
7

REFERENCES
Caramanis, C.V., 1999. International accounting firms versus indigenous auditors: intra-
professional conflict in the Greek auditing profession, 1990-1993. Critical Perspectives
on Accounting, 10(2), pp.153-196.
Francis, J.R., 1984. The effect of audit firm size on audit prices: A study of the Australian
market. Journal of accounting and economics, 6(2), pp.133-151.
Rezaee, Z., 2004. Restoring public trust in the accounting profession by developing anti-fraud
education, programs, and auditing. Managerial Auditing Journal, 19(1), pp.134-148.
Willett, C. and Page, M., 1996. A survey of time budget pressure and irregular auditing practices
among newly qualified UK chartered accountants. The British Accounting Review,
28(2), pp.101-120.
De Beelde, I., 2002. Creating a profession ‘out of nothing’? The case of the Belgian auditing
profession. Accounting, organizations and society, 27(4-5), pp.447-470.
Dedoulis, E. and Caramanis, C., 2007. Imperialism of influence and the state–profession
relationship: The formation of the Greek auditing profession in the post-WWII era.
Critical Perspectives on Accounting, 18(4), pp.393-412.
Elliott, R.K. and Willingham, J.J., 1980. Management fraud: Detection and deterrence. New
York: Petrocelli Books.
Munir Sidani, Y., 2007. The audit expectation gap: evidence from Lebanon. Managerial
Auditing Journal, 22(3), pp.288-302.
8

9

10