Analysis of Audit Exemption Thresholds in the UK and EU - 2018

This essay provides a detailed analysis of audit exemption in the European Union and the United Kingdom. It begins by exploring the history of audit exemption in the EU, focusing on the role of the European Parliament and the thresholds set for small sector enterprises. The essay then examines the specific changes in audit exemption thresholds in the UK, highlighting the country's utilization of increased limits for balance sheets and turnover. Arguments for and against audit exemption for small companies are presented, considering factors such as shareholder information needs, cost savings, internal control improvements, and the potential for increased corporate fraud. Finally, the essay discusses whether audit exemption thresholds should continue to increase, advocating for annual reviews to adapt to changing business conditions and address loopholes. The document is a student contribution, and Desklib offers a platform for students to access similar solved assignments and study resources.

ACCOUNTING &
FINANCE ASSIGNMENT
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2018
UNiversity Name
Student’s name
Hewlett-Packard Company

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By student name
Professor
University
Date: 25 April 2018.
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Question No. 1
Question: Research the history of audit exemption in the European Union and discuss the changes in
audit exemption thresholds in the United Kingdom.
In the European Union, the Parliament of Europe decides and governs which all are entities that are
required to be subjected to the Statutory Audit and what all entities are exempted from this. Similarly,
in the recent resolution of 2013 by the European Parliament, it was stated that all the companies, which
have been specified as the small sector enterprises, or companies would be exempted from the
requirements of the statutory audit (Boccia & Leonardi, 2016). So only, the public sector entities whose
shares and securities are listed and traded on the stock exchange or are insurance providers or financial
and lending institutions or those, which have been specifically named or prescribed by any member
country of European Union, will be required to get statutory audit conducted. There have been many
thresholds, which has been prescribed in the European Union for the entities, which will be exempted
based on the balance sheet or the turnover analysis. These thresholds are periodically reviewed based
on requirements and the limits have been lowered in 2013 as compared to those as stated in 2006 and
2011 regulations (Chron, 2017). As per the new regulation, a company can be categorized as the small
sector undertaking in case it fulfils any of the two requirements of the three mentioned:
1. The number of employees should not exceed 50 who are on payroll of the company
2. The total of the balance sheet should not exceed 4 Mn Euros
3. The net turnover of the company should not be more than eight Mn Euros.
However, since the various member countries have different issues therefore, they have been given an
option to increase this limit to the maximum of EUR 6 Mn for balance sheet and EUR 12 Mn for
turnover. In addition to these relaxations, the exchange rate fluctuation of 5% between the local
currency and EURO has also been allowed by the legislation (Werner, 2017). In spite of this relaxation of
the increase in the limits, the same has been exercised only by one third of the member countries and it
is evident of the fact that how much reliance and trust is being placed on the role of the statutory audit
of the enterprises. This is because audit helps in safeguarding the interests of the economy, the country
and the shareholders at large. It has been stated that even the small companies can go for statutory
audit on a voluntary basis if they want to get their accounts audited.
In the case of United Kingdom, the requirements do change a lot and the thresholds prescribed are on
the higher end. Most of the requirements to be classified as the small companies are same as that of the
small undertaking as prescribed above however, when it comes to defining the small companies (which
do form a part of the group companies) to be eligible for audit exemption, the regulations do change a
lot. Like those subsidiary companies, which do satisfy the conditions and provisions laid down in section
497A and do not fall under the classification laid down in Section 497B also qualifies for the exemption
from statutory audit (Gooley, 2016). For UK is one of those countries which have utilised the benefit of
increasing the threshold for exemption in terms of the balance sheet limits and the turnover limits and
the increase in terms of pounds is quite significant. This move has primarily been taken by the US tax
makers in order to remove the complexities, improve the ease of doing business and reduce the audit
costs, thereby improving the country’s index and ranking (Guragai, et al., 2017).
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Question No. 2
Question: Present your arguments both for and against audit exemption for small companies
There have been many arguments both in favour as well as against the audit exemptions, which have
been provided to the small companies. Arguments in favour of the exemption have been listed below:
1. Audits are generally performed to keep the shareholders of the company informed of the
financials and to meet their information requirements but in case of the small companies,
generally the shareholders are in form of the promoters of the company. Therefore, the public
funds are not involved and as promoters of the company, they would usually want to reduce the
compliance, accounting and the legal costs and therefore would not be interested in the
expending funds on getting the audit done for the company (Knechel & Salterio, 2016).
2. There are a number of small companies, which form the major chunk of the European economy
and United Kingdom being one of the major countries; it forms the backbone of the same. They
are critical not only in terms of monetary contribution but in terms of innovation ideas and skills
that they bring to the table. The exemption would lead to savings of the costs for the
companies, which would have a positive impact on the results of the business, the income as
well as tax collection for the economy to grow as a whole.
3. Furthermore, statutory audit is something, which focuses on the compliance of accounting and
legal regulation and standards. Instead of the same, the small companies could invest their
funds in the improving the internal controls of the company and thereby strengthening the
control and compliance, which would help the business grow multiple times and thereby
achieve business goals and objectives (Kew & Stredwick, 2017).
4. Exemption for the small companies would mean lesser compliance procedures and burden on
them and therefore there would not be requirement of extra human resource for looking after
that. Furthermore, the human resource already employed would have to devote less of time on
the accounting and taxation perspective and they can focus more on research, business growth
and innovation. This would help in increasing the profitability and productivity in business. This
would also promote the growth of the start-up companies as they would not suffered from
compliance failures when the human resource is less during the initial stages (Dichev, 2017).
Similarly, some of the arguments, which were against the audit of the small companies, are listed below:
1. Off late, there compliance have increased and simultaneously the quantum of frauds have
increased involving both the companies as well as the auditors. In case more companies are kept
out of purview of audit, their annual accounts will be more susceptible to corporate frauds and
the same may remain undetected in the absence of audit. This might also lead to erosion of
trust between the owners, management and external stakeholders like those of lenders,
debtors, creditors. Once the company is listed in the future, all these undetected frauds might
lead to serious compliance issues and erosion of mutual trust between the shareholders and the
management when the same is reported and established (Kangarluie & Aalizadeh, 2017).
2. In case the audit is not done, this could lead to the erosion in the quality of the financial data of
the small companies, which is available for public use. Furthermore, in case there is no
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regulation on what the companies are doing and how they are financially performing, it might
become increasingly difficult for the banks and the financial institutions to grant loan and
financial assistance, as they will be sceptical of recovery and the overall financial performance
and growth of the company. This is turn might have the negative impact of increase in higher
debt cost compared to lesser savings because of non-conduction of audit (Vieira, et al., 2017).
3. The less of audits and clientele may also have a serious impact on the performance as well as
the independence of the auditors as they would be sceptical in losing the audit and the clientele
in case the true and fair opinion is given. This will only have the indirect impact on the quality of
the financial reporting, the public information and the accounting and auditing profession as a
whole.
4. The process of conduction of audit and the setting up of the thresholds for the company is a
periodic affair and therefore a lot of uncertainty and inconsistency is attached to the same. A
small and growing company, which is not subject to audit in the current year, may become
eligible for compulsory audit in the succeeding year because of breaching the limits and
therefore the audit process becomes too complex, cumbersome and critical for the auditor, as
they have to undergo the comparative analysis for the company. The increase in audit efforts
would also mean increase in the audit cost for the first year and thus it is recommended that the
audit should be in continuance for the growing companies once it has started (Félix, 2017).
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Question No. 3
Question: Discuss if the audit exemption threshold should continue to increase.
The question discusses on whether the audit exemption limit should be held and kept constant and held
at its present limit or should be reviewed and changed year on year. As per the changing business
conditions, the ideal scenario would be to have the review of the limits and the thresholds year on year
as there are several factors which needs to be reviewed and studied. Some of these are:
1. The business conditions and the global markets are very dynamic and keeps on changing every
moment, some of these parameters include interest rate, exchange rate and the rate of
inflation. The company’s assets, which are worth EUR 4 Mn as of now, may be worth more or
less a year from now depending on the circumstances of the case and the government
regulations, which keep on changing from time to time. Similarly, the turnover limit of EUR 8 Mn
may be irrelevant from a year now considering the growth in global markets, the domestic and
international demand and supply or the economic slowdown (Sithole, et al., 2017).
2. There might be few companies for whom the nature of the operations might be complex and
would not be easy to interpret in the absence of the expert and therefore an expert opinion
from the auditor is compulsory in such cases. Therefore, even though the company qualifies the
requirements of the exemption limit the same is presumed to be irrelevant in such a scenario.
3. Any provision or law cannot stand the test of time and cannot stay forever as it is without
modifications and changes as the business condition and the environment in which it regulates
keeps on changing constantly (Appelbaum, et al., 2018). Furthermore, it is in the human nature
to find out the loopholes in the laws and the provisions and to suit their activities as per their
needs. To even out and stop the malpractices, the policy makers and the governance team
needs to analyse, review and bring in the changes as per the circumstances of the case and to
address the gaps and loopholes as and when required.
4. There are other internal and external factors, which might be of significance to the country. Like
for some countries, one or more of the industries is of special economic importance (e.
manufacturing or service industry or aircraft or defines equipment industry) and therefore the
government has a special vigilance on the performance of these companies regardless of the
scale of operations and the size of turnover and assets. In such a case, the government may
decide to keep such companies out of the purview of the exemption and may order compulsory
audit to be conducted for the class of the companies (Dumay & Baard, 2017).
5. One of the thresholds is also in respect of the employee headcount and by the use of it, many of
the companies claim and enjoy the exemption benefits even when they are more machine
intensive and not labour intensive. They are more dependent on the automated processes and
are more technologically driven and hence it should be mandated that all such companies would
be required to do audit compulsorily regardless of the number of employees. Secondly, the job
scenarios are changing dynamically in the employment market and focus in more on robotics,
automation and machine processes, where the number of employees is bound to be on the
lower side and therefore the limit of the number of employees should be reviewed periodically
and should change year on year (Lessambo, 2018).
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References
Appelbaum, D., Kogan, A. & Vasarhelyi, M., 2018. Analytical procedures in external auditing: A
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Boccia, F. & Leonardi, R., 2016. The Challenge of the Digital Economy. Markets, Taxation and
Appropriate Economic Models, pp. 1-16.
Chron, 2017. five-common-features-internal-control-system-business. [Online]
Available at: http://smallbusiness.chron.com/five-common-features-internal-control-system-business-
430.html
Dichev, I., 2017. On the conceptual foundations of financial reporting. Accounting and Business
Research, 47(6), pp. 617-632.
Dumay, J. & Baard, V., 2017. An introduction to interventionist research in accounting.. The Routledge
Companion to Qualitative Accounting Research Methods, p. 265.
Félix, M., 2017. A study on the expected impact of IFRS 17 on the transparency of financial statements of
insurance companies. MASTER THESIS, pp. 1-69.
Gooley, J., 2016. Principles of Australian Contract Law. Australia: Lexis Nexis.
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Knechel, W. & Salterio, S., 2016. Auditing:Assurance and Risk. fourth ed. New York: Routledge.
Lessambo, F., 2018. Audit Risks: Identification and Procedures. Auditing, Assurance Services, and
Forensics, 3(1), pp. 183-202.
Sithole, S., Chandler, P., Abeysekera, I. & Paas, F., 2017. Benefits of guided self-management of attention
on learning accounting. Journal of Educational Psychology, 109(2), p. 220.
Vieira, R., O’Dwyer, B. & Schneider, R., 2017. Aligning Strategy and Performance Management Systems.
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