Audit exemption under the new regime from October 2012
During the faculty roadshow on Efficient and Effective Auditing of Smaller Entities there were lots of delegate questions on the exact workings of audit exemption under the new regime from 1 October 2012. Here are some interesting examples.
Q. My client is a property company and has a year end of 30 June 2012. When can it take advantage of the relaxations in the workings of audit exemption?
A. From periods ending on or after 1 October 2012, companies are eligible for audit exemption if they meet the small company criteria (s382 CA 2006). Namely they have to meet two out of the following three conditions:
Balance sheet total (i.e. gross assets) < £3.26m
Turnover < £6.5m
Employees < 50
It nearly goes without saying that previously to enjoy audit exemption, companies had to meet both the assets and turnover criteria. It is noteworthy that your client is a property company, because these types of entities will probably be among the main beneficiaries of the latest changes as their high-asset numbers previously scuppered any chance of exemption. Your client will first be eligible for audit exemption under the new regime for the year ending 30 June 2013. Alternatively, if the directors want to, they could extend their accounting period and make their accounts up to a period ending on or after 1 October 2012. However, the directors should exercise some caution in this. The board should ensure that an audit is not required for any other reason, such as banking covenants or shareholder agreements. Also, if the board wants to move the year end it needs to think carefully about any legal or commercial repercussions. As a broader point, certain businesses or entities select their year end for practical purposes. For instance a school has a July year end for a good reason.
Q. My client has a year end of 30 September 2012. When can they take advantage of the relaxations in the workings of audit exemption?
A. On the face of it your client will have to wait until 30 September 2013 before enjoying the benefits of this change because their accounting period ends a single day too early. However, if the directors want to, they could make up their accounts up to seven days either side of their accounting reference date without the need to change their normal year end. So they could make their accounts up to 1 October 2012 and hence enjoy the benefits of audit exemption. As in the previous question, however, thought needs to be given to whether there are any legal or commercial reasons why an audit is needed.
Q. I audit a UK group with a non-trading holding company and four substantial trading subsidiaries. The directors have heard that the subsidiaries can take advantage of audit exemption now. I have tried to discourage them because of the complexity of the law and the commercial risks associated with intergroup debt guarantees. Am I right to be so cautious?
A. In short, you are right to be cautious. Some commentators suggest that the benefits of the subsidiary audit exemption can be small and indeed are often outweighed by the costs. As you are aware, from periods ending 1 October 2012 a new exemption from audit is available for subsidiaries with an EEA (European Economic Area) parent that is willing to guarantee the subsidiaries’ debts and liabilities. The main feature of this exemption which should prompt caution in the directors is the need to guarantee the debts and liabilities of the subsidiaries taking advantage of audit exemption.
In respect of your client, the results of the subsidiaries will still need to be audited because these results are included in the audited consolidated accounts and would seem to be material.
The audit work will be at group level materiality and taking into account group level risk. Nevertheless, the auditor is still required to understand the entity, assess risk and so on, regardless of whether a separate audit opinion is expressed on the subsidiary accounts individually. Many delegates at recent faculty roadshows have expressed the view that the cost savings to the client will be small, especially when compared with the elevated risks that some groups could be taking with intergroup debt guarantees – and this is something that will be addressed in the next issue of Audit & Beyond.
Additionally, there are other requirements placed on groups wishing to take advantage of these exemptions, namely:
- an annual, unanimous declaration by the company’s shareholders to dispense with an audit;
- the parent undertaking draws up audited consolidated financial statements that include the subsidiary and disclose in the notes that the subsidiary has taken advantage of this exemption;
- the shareholder’s declaration and the statutory statement of guarantee, together with the parent’s audited accounts, must be filed by the subsidiary at Companies House; and
- the company’s balance sheet must contain a statement signed by the directors that it has taken advantage of the exemption.
This is, of course, in addition to the parent undertaking a statutory guarantee of all outstanding liabilities to which the subsidiary is subject at the end of the financial year to which the guarantee relates.
Having said all of this, there will be circumstances when taking advantage of audit exemption in this way might be the right thing for a group to do. For instance, when there are many small subsidiaries the auditors’ work might be significantly reduced. Also, in certain groups the holding company might have effectively guaranteed the debts of the subsidiaries legally or formally, or it might be culturally unthinkable for a group company to fail to meet its obligation.
Q. I audit a subsidiary of a French quoted company. Can the subsidiary now take advantage of audit exemption?
A. The fact that the holding company is French and quoted does not necessarily present a problem. A quoted company cannot take advantage of the exemption but a member of a group containing such entities can. Also, the exemption is available to any UK company with a parent in the European Economic Area. However, the directors of the holding company need to be fully aware of the extent of their obligations (as highlighted above) before taking advantage of the exemption.
Q. I audit a large group where two subsidiaries are insurance companies. Can any subsidiary of the group take advantage of audit exemption?
A. There are certain entities that are ineligible for the subsidiary audit exemption, and audit exemption in general for that matter, namely:
- quoted companies;
- authorised insurance companies;
- banking companies;
- e-money issuers;
- MiFID investment firms;
- UCITS management companies;
- companies undertaking insurance market activity; and
- trade unions and employers’ associations.
Therefore, the insurance companies in the group will not be eligible for the subsidiary audit exemption. However, the other companies in the group may be eligible.
Q. Do the changes to audit exemption apply to LLPs as well as companies? And what is changing for dormant companies?
A. Yes, exemption applies to both LLPs and companies. Dormant companies are already usually eligible for audit exemption. However, from 1 October 2012, dormant subsidiaries will also become eligible for an exemption from preparing and filing their accounts at Companies House.
John Selwood is a member of the faculty’s Practitioner Services Committee.
This article first appeared in the November 2012 edition of Audit & Beyond, the magazine from the ICAEW Audit and Assurance Faculty.