The rules for micro entities are supposed to be straightforward. The accounts certainly are. Micro entities’ financial statements include a simple balance sheet and do not need a profit and loss account or a directors’ report. Unlike accounts produced under UK GAAP, there’s no fair value accounting and no deferred tax, making measurement a synch.
When it comes to audit, the picture seems even simpler. The Companies Act specifically states that accounts which comply with FRS 105 are deemed to show a true and fair view. While this presumption did raise a few eyebrows when first published, the sense was that audit was never going to be much of an issue for micro companies. Since they fall outside the audit threshold the assumption was that these companies would rarely, if ever, want an audit.
To the surprise of many, requests for micro entity audits have turned out not to be quite as unusual as expected. This has given auditors a real problem. How can they give an opinion on a set of financial statements that the law states show a true and fair view when there is so little information on which to base that judgement?
Taking a view
Normally auditors would insist on there being additional disclosures that are not specifically required if they felt that users needed this extra information to get the full picture from the accounts. But company law stops the auditors of micro companies from asking for these additional disclosures – because it says that by default accounts produced under FRS 105 show a true and fair view.
But it’s hard to say that a set of accounts that comprises a balance sheet and a couple of statements give a true and fair view in the traditionally accepted sense, says Matt Howells, director at Smith & Williamson. “You’ve got no profit and loss account, and no notes. And yet these accounts are deemed to give a true and fair view in law. This was the problem we faced.”
Some firms did not think they would carry out micro company audit engagements. One of these was Price Bailey. First off there are commercial questions to answer, says partner Catherine Willshire. “If an entity is that small, you have to look at the cost-benefit analysis of complying with the regulations.” She agrees that a set of micro entity accounts produced under FRS 105 don’t tell users much at all.
“You could be in a position where technically the accounts comply with the standard and are deemed to give a true and fair view, but they could be misleading because they do not include certain explanations that might be important for users.”
It soon became clear that this conundrum was exercising the minds of ICAEW members at small and medium-sized practices. “We had members asking us what a micro entity audit report should look like, and how should we word it,” says Ray Farren, ICAEW technical adviser. “This is a critical issue, which is why the Institute got working on how to minimise members’ exposure.”
The key question that needed addressing was: how could members in practice ensure that those reading the financial statements did not misunderstand the term “true and fair” when used in a micro company audit report?
To address this, ICAEW went back to the audit standards. ISA (UK) 210 is clear that FRS 105 is a compliance framework, not a fair value framework, says ICAEW Audit and Assurance Faculty technical manager Chris Cantwell. “It acknowledges the risk that the audit report could imply that the micro entities’ regime is a fair presentation framework, which it clearly isn’t.
“To prevent this happening, it suggests that auditors include an “other matter” paragraph in the audit opinion. This states that the accounts have been prepared under the micro-entity regime and makes clear the limits on the disclosures required to give a true and fair view.”
This “other matter” paragraph is one of a number of issues covered in the Faculty’s helpsheet Preparing an audit report for micro-entities, which was issued earlier this year. While the true and fair view issue was the biggest headache auditors faced, it wasn’t the only one, says Philip Lenton, Deloitte director and chair of the ICAEW working group that wrote the helpsheet. “When you get into drafting the other parts of the audit report you have to think about each section,” he says. “For instance, there are various matters that the auditor reports on by exception that we thought still needed to be included in the audit report, even though they weren’t particularly relevant to micros, because the requirements on auditors hadn’t been sufficiently tailored to deal with micro audits.”
Then there’s going concern. An example of the potential problem came from a member with a client who had realised that taking advantage of the micro entity regime would mean no going concern disclosure. “The company was saying that the audit report should show a true and fair view because going concern disclosures are not required,” says Cantwell. “But while the minimum disclosures in the Companies Act do not appear to require specific disclosure of material uncertainty in relation to going concern, ISA (UK) 570 does. This means there’s no get out, as the helpsheet makes clear.”
Value of the audit
Given the costs involved in a statutory audit, the question has to be: why should micro-entity companies bother? The audit report basically says that the company has complied with the accounting framework and that the accounts do what they are supposed to do, nothing more.
It turns out that there are a number of reasons why. Some companies simply want the confirmation that their accounts have been reviewed by an independent professional. A number of lenders want to see audit opinions; in other cases having an audit has been a performance requirement on a contract. In one example, having an audit was seen as a question of prestige. In another, an investment vehicle had many small subsidiaries, one for each type of investment. The individual companies met the definition of micro entities but as they all had external investors they each wanted an audit.
The fact that the auditor has issued an audit report gives the accounts some sort of seal of approval, says Howells. “If we came across anything that was not right, we wouldn’t issue an unqualified report. The audit report gives the user a level of comfort that the accounts have been looked at, and not just from a compliance perspective – that there is some rigour in the balance sheet.”
Because the accounts still need to show a true and fair view, members should try to encourage whatever disclosure they feel is relevant to achieving this, says Farren. “If the client wants to produce something that the member is not comfortable with, then they should consider withdrawing from the engagement. We would always advise them to discuss this before agreeing to take on the audit.”
This pre-audit discussion is the route Price Bailey took. “We told our micro entity clients who wanted an audit that there may be certain circumstances where it would be helpful for the readers of the accounts if there were some additional information,” says Willshire. “We came up with an agreement that both we and the client were comfortable with, and a position from which the accounts were not misleading. The clients we were working with weren’t worried about extra disclosure: they weren’t moving away from FRS 102 because of disclosure but because of the fair value measurement. We weren’t asking them to disclose anything that they hadn’t disclosed before so they were quite comfortable with this. And we didn’t fall foul of company law because we had this discussion before we accepted the appointment as auditors.”
This type of discussion helps set the ground for an appointment. When the work starts, the helpsheet guides members through the complexities of the law and standards, says Lenton. “It also explains the rationale behind the changes in micro-entity audit reports. If we had just given the report and nothing more, members would not necessarily have understood why it had changed and some of the nuances that we’ve explained and the reasons for them. This is why we feel that members undertaking this kind of engagement should read the whole helpsheet.”
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