The bookkeepers and accountants of a business entity are responsible for recording transactions and applying different formulas to prepare financial statements. The financial statements are viewed as a point of communication with the shareholders and other external stakeholders.
The information presented in the financial statements serves as a trigger for stakeholders’ different economic and financial decisions. Therefore, a true and fair view of information in financial statements is very crucial. It can be made possible if a company’s accounts and financial statements are independently reviewed, analyzed, and verified to comply with regulations and financial reporting protocols.
The review and verification of data can be conducted by external parties, or agencies specialized in the field, or internal professionals trained to verify and validate the recorded transactions. There are two protocols around the world for financial reporting: GAAP and IFRS. The European countries and most of the other countries in the world follow international financial reporting standards. However, Generally Accepted Accounting Principles are followed in the US.
The difference in accounting and reporting standards is dictated in different procedures across businesses operating in distinct regions. However, the verification and analysis of the financial statements are known as an audit. There are certain exemptions to audit requirements and subsequent thresholds relating to the exemptions.
This article will go through the audit exemptions and thresholds in Europe effective from Jan 1, 2016.
What Is An Audit?
An audit is an official examination of the accounts or accounting system of a business entity by an auditor. The term has been derived from the Latin word ‘Audire,’ which means ‘to hear.’
A more formal definition of an audit can be as follow:
It is the examination and inspection of various books of accounts by an auditor. It involves analyzing the physical evidence of business transactions, checking physical inventory and respective documents. The auditor performs an audit to obtain reasonable assurance that what is stated in financial statements represents a true and fair view.
International Federation of Accountants(IFAC) define an audit as,
An audit is an independent examination of the financial information of an entity. Whether profit-oriented or not, regardless of its size or legal form, the examination is conducted to express an opinion thereon.
After the audit, the auditor prepares an audit report that explains the opinion and independent judgment of the auditor about the entity’s accounts and financial statements.
What Are Purposes Of An Audit?
The purpose of the audit is to convey an opinion on whether or not the financial statements of a business entity are prepared according to an applicable financial reporting framework.
The broader objective of an audit can be subdivided into two categories: primary purposes and secondary purposes.
The primary purposes of the audit are as follow:
- Examination of the internal control and internal check system
- Checking arithmetic authenticity and accuracy of books of accounts, verification of posting, casting, balancing, etc
- Checking the physical evidence and validity of business transactions
- Examination and analysis of different items categorized as capital and revenue nature
- Verifying and confirming the value and existence of assets and liabilities
The secondary purposes of audit involve the following:
- Detecting and preventing the errors
- Detecting and preventing fraud and embezzlements
- Detecting and preventing the undervaluation or overvaluation of the inventory
Types Of Audit
There are three types of the audit performed by different business entities: external audit, internal audit, internal revenue service(IRS) audits.
The professionally trained auditor performs the internal audit as the first checkpoint for an organization. With the help of an internal audit, the business entity can examine and confirms if the internal control, procedures, books of accounts, and SOPs are followed in all respects.
The internal audit is performed by the employees and internal stakeholders of the business entity. The scope of internal audit is extended to verification and assessment of books of accounts, operational activities, IT infrastructure and security protocols, internal control and procedures, etc. The internal audit helps the organization achieve strategic objectives, external regulatory requirements, and internal control and check implications.
Independent, third-party firms and agencies experienced in auditing perform the external audit of any business entity. The external audit entails verification, assessment, and examination of a company’s financial statements to confirm all procedures are in compliance with the external regulatory procedures, norms, and controls.
The external audit is usually public and mandatory for corporations. The external audits are performed as a requirement by shareholders to know if the company’s management has been performing in the best interest of the company’s owners. The final audit reports are presented to shareholders in annual general meetings.
As the name suggests, the Internal Revenue Service(IRS) audit is performed to verify taxpayer’s return and information reported in return filed for taxation purposes. The IRS auditors are also independent auditors hired by the IRS to examine the statements of tax returns.
The IRS audit is not mandatory, and the department decides if a taxpayer’s return will be audited or not. Therefore, the IRS audit doesn’t need to only be performed if the business entity or individual is suspected of being involved in wrongdoings. The decision of audit can be just for rectification of any unintentional errors or omissions too.
Audit Exemptions And Thresholds
The amendments were made in the Companies, Partnerships, and Groups regulations regarding accounting and reporting in 2015. The new rules and regulations were implemented in the following financial year starting from Jan 1, 2016.
The audit exemptions and subsequent thresholds were defined for companies, partnerships, groups, charities, and community benefit groups according to the regulations.
In the case of companies, small or stand-alone companies(regulated by one person) must meet the criteria of small businesses to get an audit exemption. Under the companies act 2006, section 382 to 384 defines the qualification criteria as a small business.
According to the regulations, a company will be treated as a small company if it fulfills the following criteria(two requirements at least):
Turnover: Gross turnover must be less than 12.2 million GBP and net turnover less than 10.2 million GBP
Total Assets: Gross assets than 6.1 million GBP and net assets less than 5.1 million GBP
Number Of Employees less than 50
The requirements must be met for two consecutive years to get an audit exemption.
However, suppose the limits are exceeded for more than two consecutive years. In that case, it will no longer be treated as a small business. The audit will become mandatory for a company if:
- A public limited company
- A subsidiary of a company that does not meet the criteria of a small company
- An authorized and registered insurance company that actively work in the insurance market
- Financial institutions providing banking services or electronic money
- MiFID(Market in Financial Instruments Directive) investment firms that deal in marketable financial instruments and securities
- Any corporate body whose shares are traded in the stock market of any European state
Groups are NOT EXEMPT from the audit requirements if they don’t meet the criteria of a small business. The threshold limits for the groups remain the same as for companies. However, a difference is that a group must fulfill all three thresholds to claim as a small company and get an audit exemption.
If the requirements are not met, every group member will be mandated to perform an audit. Still, subsidiaries are exempt under section 479 of the Companies Act 2006.
For the private limited companies, the old audit exemption would be made a whole group ineligible for audit exemption. However, the new regulations, a group will be ineligible for an audit exemption in the presence of a PLC only if the PLC is a listed company on London Stock Exchange.
A small company present in a group is principally exempt from audit. However, the small company might be mandated to perform an audit for the following reasons:
- A lender of the company requires to perform an audit
- On the urge of higher management to insurance audit assurance and compliance
- According to the regulations, constitution, and internal checks of a company, an audit might be required
- An audit might be performed by a small company when preparing for sale
The thresholds for companies and groups were the same, with the difference in fulfilling requirements. However, the audit exemption thresholds are different for Charities and community service groups as per regulations applicable since 2016.
Less than 500,000 GBP for the charities working in Scotland and Northern Ireland
Less than 1 million GBP for the charities registered in other parts of the UK
Less than 3.26 million GBP in the whole UK
Less than 250,000 GBP across the UK
If the threshold is met by a charity, it is the choice of the institution to perform a full audit or not. However, the charities and non-profit organizations exceeding the discussed thresholds will have to go for a full audit. A full audit will be mandatory of a charity group having gross income less than 1 million GBP and more than 25,000 GBP
In this article, we’ve discussed the process, definition, scope, types, and purposes of audit to help you understand. The audit is performed to verify the trueness and fairness of the financial statements. There are two types of accounting standards followed internationally: GAAP and IFRS. However, certain groups, companies, and business entities are exempt from full audits.