The new Companies Act stipulates that only listed companies, and companies deemed to be in the public interest, are required to be audited and that non-public companies may choose between an independent review or an audit.
Given the value of an audit for non-listed companies – mostly small-to medium-sized entities (SMEs) – this “choice” with regard to the previously mandatory requirement seems like a “privilege” with very little benefits.
It becomes imperative for these directors to understand that an audit is not an expense, but an asset that will yield returns far greater than the original investment. An audit provides a platform, both financial and non-financial, on which non-public companies should build to meet future challenges.
According to the International Federation of Accountants (IFAC), SMEs account for more than 95% of all companies around the world. Governments – including South Africa – believe that provisions, as outlined in the new act, help to lower the regulatory burden and cost for SME’s thereby promoting entrepreneurship in this vital sector of the economy. While few dispute the need to reduce red tape, lessen the regulatory burden and remove the “one-size-fits-all” approach to regulation, certain checks and balances must remain in place so that growing businesses establish good management practices as they become economically significant.
In a recent paper entitled “The Value of an Audit to Small and Medium Sized Businesses,” Pitcher Partners indicate that an independent audit provides far more than “public accountability” and plays a key role in promoting good business practices throughout the economy. It emphasises that the role of audit is critical to guiding governance in smaller companies before they become economically significant, thereby reducing business failure.
An audit provides immediate benefits, with one of the most practical and beneficial returns being the management letter that identifies any processes or operational deficiencies requiring correction or improvement. Having an audit performed on its financial statements will prepare a company for the immense challenges it will encounter as it grows and develops into a more complex organisation, especially if it is a potential candidate for external funding to facilitate expansion or even, ultimately, listing on the JSE.
Removing audit requirements for non-public, owner-managed companies may not result in less bureaucracy and lower cost obligations says IFAC. In its recent research entitled “The Expanding Role of SMPs in Advising SME Clients,” IFAC points out that due to limited capacity and expertise, SMEs frequently need to seek external advice and support. The publication highlights that the changes in regulation in other areas, such as employment rights and environmental regulations, overshadows the relaxation in statutory audit provisions. Despite movements to reduce regulatory “burdens” on SMEs, The World Bank found that the market for advice and support is substantial. In the UK, for example, the Business, Enterprise and Regulatory Reform estimate that businesses spend at least £1.5bn to help them deal with regulations.
An external audit regulation for SMEs ensures that they comply with other laws – a by-product of any audit – which, according to the research paper, remain as unavoidable costs for SMEs in any case. Audits not only reduce the risk of business failure, but equip smaller businesses with an understanding of how to develop management practices that enable them to grasp opportunities while mitigating risk. To grow and prosper in a vibrant SME market, concludes the report, requires an audit which provides the essential outcomes and skills necessary to do so.
The corporate law reform process by allowing non-public entities to choose between an audit and an independent review may do more harm than good. What may seem like a blessing to those who view audits as an unnecessary and costly annual exercise may turn out to be their only safeguard when faced with multiple offences and breaches of the Companies Act. Directors should not fall victim to the misconception that an independent review is necessarily cheaper than an audit. Based on this erroneous belief, the choice of an independent review could prove to be a fatal mistake by not considering the potential cost of a lower level of assurance.
According to research commissioned by KPMG and conducted by Opinion Leader Research, involving an in-depth survey of 200 UK companies, the underlining “importance of the audit process to businesses, nearly two thirds (62%) of the companies that participated in the survey claim that they would conduct their own audit process even if it were not a statutory obligation”.
The advantages of engaging an external auditor to audit financial statements far outweigh the cost of not having one since auditors play an important role in the success and growth of a company – more so for non-public companies that are expanding rapidly.
(Project director of assurance at the South African Institute of Chartered Accountants (Saica))
This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice.