Dodging the audit bullet: relief for small businesses
The majority of South African owner-managed companies can at last breathe a sigh of relief that they are now officially exempt from an obligatory annual audit.
The exemption has survived at least a decade of redrafts of the new Companies Act and its regulations, and intensive lobbying by accountants, auditors and the tax authorities in favour of auditing.
The final audit threshold that was released in the Companies Act regulations 10 days before the May 1 implementation date is considerably lower than the level mooted in the draft regulations, but it is still high enough to exempt all but the most substantial companies.
The regulations introduce a public-interest point system for the first time, which is aimed at calculating to what extent the South African public apart from the owners has a stake in the company. A company scores one point for every employee, one point for every R1 million in turnover, one point for every R1 million in third-party debt and one point for every shareholder.
The lowest level of the threshold is for those companies that do their accounting internally, in other words, they employ their own accountant instead of outsourcing their books to a firm of independent accountants. Such companies must have their books audited if they score 100 public-interest points. Companies that use outside accountants to do their books only have to undergo annual auditing if they score 350 public-interest points.
The Companies Act is remarkably lax for small companies managed by their shareholders, prescribing only that annual financial statements be drawn up if they fall under the audit threshold. But for companies that have shareholders who are not actively involved in the management, for example silent shareholders or family trusts, the Act prescribes an annual independent review, a light form of audit.
Jan du Toit, whose accounting and business-advice practice Enablis services owner-managed businesses, is sure that there will be a substantial fall-off in the number of companies that opt for audits now that it is no longer obligatory. He believes the biggest driver will be the cost, which comes to at least R20 000 for an annual audit.
The kind of assurance that a small company gets for that price is simply not worth it, says Du Toit. An audit firm would send a junior clerk to a small company, who would spend two days auditing the books. “How many things can they possibly check in two days?”
Du Toit says the most common attitude among owner-managers is likely to be the following: “I am in charge of my business myself. If something goes wrong, I have a nine-out-of-ten chance to pick it up. I’d rather run the risk of the one-out-of-ten chance that I won’t.”
But Ian Scott, managing partner at Grant Thornton in Cape Town, says businesses need to consider more than just the cost of the audit. It can serve as an important independent check for the owner on the performance of his business. An audited history is also helpful for the sale of a business, and financiers may insist on audits.
Du Toit, who assists many of his clients with finance applications, believes that the banks are unlikely to insist that owner-managed businesses must be audited if they want finance. The banks have very sophisticated systems to study the movement of cash in and out of a business’s bank account and compare it to industry averages. A bank can learn more about the health of a business by studying its bank statements than its audited financial statements, he says.
Christo Botes, the executive director of the small business finance house Business Partners, says his organisation is likely to insist on an annual audit only where it holds shares in the businesses it finances. This accounts for about 15% of Business Partners’ clients. In other cases, where the financing is limited to term loans, Business Partners will only require an independent review if the risk of financing the business is high.
Franz Marent, owner-manager of local power tool manufacturer Lawn Star, says his company will continue to have its accounts audited, despite the cost involved, mainly for the purposes of “internal control”. “I personally subscribe to having clean books. (An audit) is an external check on the business, and of course when dealing with other institutions, the banks and some of the government departments, you’ve got believable statements.”
Marent says he started Lawn Star 11 years ago as a formal company because he wanted to establish credibility quickly. “We said let’s go with a formal business. Our dealings are with international people as well, and it gives the business a little more credibility. I think that is what we’re dealing with here. It’s a credibility issue.”
This article originally appeared in the Mail & Guardian newspaper as an advertorial