As of this month, private limited companies which report annual turnover of up to £5.6 million are exempt from the legal requirement to have their accounts audited.

Since all companies in the new turnover band are legally exempt from the annual audit in respect of accounting years ending on or after March 30 2004, they need do no more than claim, on the accounts which they will still have to file at Companies House, their right to file unaudited accounts.

Companies that want to continue to have their accounts audited will therefore have to make a positive decision to do this. But before they decide which way they wish to go, they should consider that dispensing with the audit is not quite the simple story of saving money.

The main purpose of the audit is to allow an independent expert to review a company’s accounts and to give an opinion on whether they are prepared in accordance with legal rules and best accounting practice, and that they amount to a faithful reflection of the financial transactions of the company over the accounting period.

The audit process will also involve the auditor carrying out checks to identify the existence of fraud and to assess the adequacy of the company’s internal controls. If the auditor discovers any weaknesses he will report accordingly to the company’s management.

The audit process also considers whether or not the company is a ‘going concern’.

The benefits of the audit are several. Via a clean audit report, directors receive comfort that the accounts for which they take responsibility have been properly prepared and give a true and fair view.

Shareholders not involved in management receive a professional opinion on the truth and fairness of the directors’ accounts from a qualified auditor who owes them a legal duty of care. Both directors and shareholders are given the assurance that the company’s business records and internal controls have been reviewed and recommendations will have been made to make necessary improvements.

The biggest criticisms of the legal necessity for the audit usually come from very small companies in which the directors and shareholders are one and the same. They argue that, since the addressees of the report are the shareholders, then the audit report can tell them as director / shareholders nothing about the accounts that they do not already know.

However, the argument holds less weight where a company is dependent on outside finance and credit. Here the company will need to provide reliable evidence to outside parties of the soundness of its finances, and it is here that the existence of audited accounts brings direct commercial value to a company.

Most small companies pay a combined fee to the same firm for the preparation of their accounts and for the audit itself. The cost of the audit, therefore, may not always be billed separately and may form a small part of the overall fee.

An independent audit is still seen by many third parties as being the best and most trusted form of financial health check that a company can have. If a business needs loan finance then the bank or other lender will invariably want to see audited accounts as the basis for its lending decision.

The audit report gives the lender information not only about whether the figures in the accounts add up but about whether the company is a good credit risk. An unaudited set of accounts will give the reader no clue as to whether the business is likely to continue in good financial health.

If small companies have not had their accounts audited beforehand, therefore, they will very often be required to commission an audit for commercial reasons, in which case no cost ‘saving’ will in fact accrue from audit exemption.

Similarly, credit managers at companies from which a small company wishes to buy goods and services will wish to establish their financial position before doing business with them. Audited accounts will often be requested for this purpose in respect of any material level of credit.

Also, the Inland Revenue has traditionally looked to audited accounts as the basis for its determination of a company’s tax liability. If a company’s accounts have not been audited, then the Revenue may wish to seek more information and explanations from the company than it otherwise would.

JOHN DAVIES

John Davies is head of Business Law at the Association of Chartered Certified Accountants.