Understanding Audit Limits: A Guide to Thresholds and Compliance

Audit limits are a key consideration for businesses of all sizes. They define the threshold at which a company is required to undergo an external audit, a process that provides an independent examination of its financial statements. Audits can be vital for ensuring transparency, accuracy, and confidence in a business’s financial health, yet not every business is subject to mandatory auditing.

Our blog explores what audit limits are, why they matter, recent changes in the audit thresholds, and how businesses can determine whether they fall within the mandatory audit category. We’ll also delve into why a voluntary audit can still be beneficial, even if your business is below the audit limit.

---

WHAT ARE AUDIT LIMITS?

Audit limits refer to the financial thresholds that determine whether a company is legally obligated to undergo an external audit. These limits vary by country, and different jurisdictions may have their own requirements based on company size, turnover, assets, and employee count.

In the UK, for example, companies are usually exempt from mandatory audits if they meet two out of the three criteria:

1. Annual turnover of less than £10.2 million
2. Assets worth less than £5.1 million
3. Fewer than 50 employees

If a business exceeds two of these thresholds for two consecutive years, it becomes subject to an external audit. These thresholds are due to be raised as part of an effort to reduce the administrative burden on small businesses.

A small company may not be entitled to exemption, for example if:

• It’s a subsidiary of a larger group
• Its’s a listed company
• It’s articles of association require one
• Shareholders owning more than 10% of the shares ask for one

For further information please speak to our team.

WHY DO AUDIT LIMITS MATTER?

Audit limits are in place to ensure that businesses with a certain level of financial complexity or risk provide audited accounts, which are essential for shareholders, creditors, and other stakeholders. The larger the company, the greater the potential impact of financial mismanagement or error.

Audits offer an added layer of assurance that the financial statements are free from material misstatements, whether caused by error or fraud. They also help companies identify areas of internal control weakness or inefficiency, providing an opportunity to strengthen financial governance.

RECENT CHANGES TO AUDIT THRESHOLDS

Over the years, audit limits have been adjusted to better reflect the economic landscape and ease the administrative burden on smaller businesses. For instance, in 2016, the UK significantly raised its audit exemption thresholds, which allowed many small- and medium-sized businesses to avoid mandatory audits. This move aligned the UK with European Union standards at the time, making it easier for smaller businesses to comply with regulatory requirements. These limits are due to be increased again soon.

These changes were introduced to allow smaller businesses to focus their resources on growth rather than compliance, as the cost of an audit can be significant for smaller firms. However, while regulatory changes have relieved smaller businesses from mandatory audits, it’s essential to understand that even businesses that qualifies for an exemption can still opt for voluntary audits.

WHEN A VOLUNTARY AUDIT IS BENEFICIAL

Even if your business is below the audit threshold, there are circumstances in which a voluntary audit can offer significant benefits. These include:

1. Access to Finance: Lenders and investors often require audited financial statements before they provide funding or investment. An external audit can provide assurance that your financial statements are materially accurate and reliable, which can be crucial when seeking external capital.
2. Credibility with Stakeholders: For companies looking to build credibility with suppliers, customers, or potential business partners, an audit can demonstrate a commitment to transparency and sound financial management. This can improve trust and encourage long-term relationships.
3. Improved Internal Controls: Auditors will often uncover inefficiencies or weaknesses in your internal financial controls. Addressing these issues can help prevent fraud, ensure compliance with regulations, and improve overall business operations.
4. Strategic Decision-Making: An audit can offer valuable insights into your company’s financial health and operational performance. It can highlight areas of concern and provide management with a clearer picture of the business’s financial standing, leading to more informed decision-making.
5. Preparation for Growth: As your business grows, you may soon exceed the audit threshold. Conducting a voluntary audit before it becomes mandatory can prepare your company for future requirements and ensure a smooth transition when audits become compulsory.

COMMON FINDINGS IN AUDITS

When businesses are subject to audits, whether mandatory or voluntary, certain issues tend to come up frequently. Understanding these common findings can help businesses prepare better and mitigate risks before they escalate.

1. Weak Internal Controls: One of the most common findings is weak or ineffective internal controls. Internal controls are the processes and procedures put in place to safeguard assets, ensure accurate financial reporting, and promote operational efficiency. Auditors often identify gaps in these controls that could lead to fraud, errors, or non-compliance.
2. Revenue Recognition Issues: Auditors frequently identify issues with how revenue is recorded and recognised. Different industries can have different methods for revenue recognition, and it’s vital that businesses follow the accounting standards correctly.
3. Inconsistent or Poor Documentation: Poor record-keeping can lead to problems during an audit. Auditors sometimes find that businesses fail to maintain adequate documentation to support their financial transactions, which can lead to discrepancies and material misstatements in the financial statements.
4. Asset Valuation: The mis-valuation of assets is another frequent issue. Whether it’s inventory, property, or equipment, incorrectly valuing assets can lead to distorted financial statements. Auditors will typically ensure that assets are valued according to the appropriate accounting standards and that depreciation is calculated correctly.
5. Going Concern Issues: Directors are responsible for assessing whether a business is a “going concern,” meaning that it has the resources to continue operating for the foreseeable future. Auditors are tasked with confirming whether that assessment is reasonable, if there are doubts about a company’s ability to continue operating, auditors will raise this issue in their report, which can be a red flag for investors and creditors.

PREPARING FOR AN AUDIT

If your business is nearing the audit threshold or has chosen to undergo a voluntary audit, preparation is key to a smooth process. Here are some steps to ensure you’re ready:

• Strengthen Internal Controls: Review and improve your internal controls to ensure they are robust and effective. This includes segregation of duties, approval processes, and safeguarding assets.
• Maintain Accurate Records: Ensure all financial transactions are well-documented, with supporting evidence for each entry. This will make the auditor’s job easier and help avoid delays or issues during the audit.
• Review Revenue Recognition Policies: Make sure that your revenue recognition practices align with current accounting standards, and that you’re recognising revenue at the appropriate times.
• Prepare for Tax Scrutiny: Double-check your tax calculations and ensure that all liabilities have been accurately recorded.
• Assess Your Assets: Review your asset valuations and ensure that depreciation and impairments are accounted for correctly.

Understanding audit limits and preparing for potential audits, whether mandatory or voluntary, is crucial for businesses of all sizes. While some companies may fall below the threshold, opting for a voluntary audit can offer significant benefits in terms of credibility, internal control improvements, and strategic insights.

---

As audit thresholds and standards evolve, staying informed and prepared will ensure that your business remains compliant and in good financial health. Whether you’re a small business below the audit limit or a growing company subject to mandatory audits, preparation is key to ensuring a smooth and successful audit process.

Call us today on 01904 558 300, or email us at enquiries@fortus.co.uk, to discuss your audit requirements.