Why It’s Advisable To Have Your Financials Audited

Why It’s Advisable To Have Your Financials Audited

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The New Companies Act will usher in significant changes for all companies, and particularly for small-to-medium enterprises (SMEs).

It will affect their accounting practices, obligations and requirements. All companies will be required to prepare financial statements, in line with international best practice.

Requirements for financial statements

The Act sets out that these financial statements must:

  • Satisfy the reporting standards as to form and content
  • Present fairly the state of affairs and business of the company and explain the transactions and financial position of the business of the company
  • Show the company’s assets, liabilities and equity, as well as its income, expenses and any other prescribed information
  • Set out the date on which the statements were produced and the accounting period to which the statements apply
  • May not be false, misleading in any material aspect or incomplete
  • Bear, on the first page of the statements, a prominent notice indicating whether the statements have been audited; if not audited, have been independently reviewed; or have not been audited or independently reviewed; and the name and professional designation, if any, of the individual who prepared or supervised the preparation of these statements.

Audits and independent reviews

Historically, all companies – both public and private – needed to have their financial statements audited on an annual basis. But this has changed under the New Companies Act, which has introduced an alternative to the audit that is of particular relevance to SMEs.

The Act stipulates that only public companies and companies where it is considered to “be in the public interest” will need to be audited. All other companies are only required to undergo an independent review. This will be carried out by an independent accounting professional and not by a registered auditor and the aim is to lower the regulatory burden for small businesses.

Of course, small companies can still choose to be audited if they so wish, and there are benefits to be considered when making such a decision.

The independent review

The current draft regulations to the Companies Act allow for three different levels of “independent reviews”. Theashen Ashley Vandiar, project director, auditing and members’ advice, at the South African Institute of Chartered Accountants (SAICA), explains that depending on the size of assets and turnover, a company subject to an independent review may be required to:

  • Only produce a compilation report, as is currently the case with close corporations
  • Have a review performed in accordance with International Standards on Related Services (ISRS 4400), a standard that relates to “agreed upon procedures”
  • Have a review performed in accordance with International Standards on Review Engagements (ISRE 2400)

Pros and cons

On the one hand, the independent review could work out to be cheaper and less time-consuming and for these reasons has been welcomed by many small companies. An audit involves substantive procedures and requires the services of a registered auditor instead of an accounting professional.

However, as Vandiar explains, “what most fail to realise is that a review is a double-edged sword” and they need to seriously consider the value they will be getting from an independent review versus an audit.

A review will not provide the kind of assurance afforded by an audit (and frequently required by third parties such as financial institutions). Only the third kind of review, performed in accordance with International Standards on Review Engagements, provides some form of  assurance.

“An audit involves tests of controls and substantive procedures and would ultimately result in an opinion being expressed by a registered auditor. An audit results in a reasonable level of assurance. An independent review performed in accordance with ISRE 2400, on the other hand, involves only enquiry and analytical procedures. An independent review thus results in only limited assurance being expressed by a practitioner,”says Vandiar.

A review may also not necessarily be quicker or cheaper, he adds. “In order for analytical procedures and inquiries alone to be meaningful, the person performing the review needs to have an in-depth understanding of the client’s industry and business environment, as well as a detailed knowledge of the client’s internal controls, management’s background, operating functions, and prior financial performance. A trainee clerk is unlikely to possess the minimum knowledge required to conduct a review engagement that will be of benefit to the entity.” In other words, the minimum qualifications and experience expected of the person conducting the review has a direct impact on the cost of a review. Reviewers should at least have a theoretical knowledge of auditing and belong to a professional body.

They are required to perform the review engagement in line with international best practices.

In summation, Vandiar says that the most significant difference between a review engagement and an audit boils down to the time taken to complete the engagement; and the outcome in terms of the difference in the level of assurance obtained.

“An audit is likely to take longer than a review, which, however, would result in the highest level of assurance, whereas a review performed in accordance with ISRE 2400 can only provide a limited level of assurance.”

Vandiar maintains that the cost of an audit would not be significantly different to that of a review performed in accordance with ISRE 2400. “Yes, other levels of independent reviews as described in the draft regulations would be cheaper, but they do not provide any form of assurance whatsoever,” he says.

A recent survey in the UK showed that of those companies exempt from being audited, some 80% chose to have their financials audited anyway. Vandiar advises that when it comes to deciding whether to have their financials audited or not, non-public entities should consider their stakeholder needs as well as their future plans to grow and engage public interest.

Juliet Pitman
Juliet Pitman is a features writer at Entrepreneur Magazine.