- 15 Marks
Question
The Companies and Allied Matters Act, 2020 has classifications and responsibilities for various types of companies incorporated under it. A particular class that has received more attention in recent times and in the Act is small companies.
Your audit team has been approached by a few of these small companies for guidance on the issue and your team has been assigned this responsibility. Part of the concerns of your firm is whether or not those small companies merit the concerns of regulatory authorities and the accounting firms that have to be responsible for their audit.
Your team has a number of young assistants who are yet to understand the differences and therefore need enlightenment on this as part of the training programs.
Required:
a. Discuss the arguments for and against the exemption of small companies from audit. (10 Marks)
b. On the basis that an audit may be conducted for a small entity, evaluate the points the auditors would consider. (5 Marks)
Answer
a. Arguments For and Against the Exemption of Small Companies from Audit
Arguments For Audit Exemption:
- Cost Savings:
- Audits impose significant costs that small companies may struggle to afford, particularly if they have limited financial resources.
- Simplified Financial Reporting:
- Removing the audit requirement allows small companies to focus on simplified financial reporting, reducing administrative burdens.
- Low Risk to Stakeholders:
- Small companies often have fewer stakeholders, such as owners who are actively involved in management, reducing the need for independent assurance.
- Flexibility for Growth:
- Exemptions encourage small businesses to grow without the constraints of meeting audit requirements, fostering entrepreneurship.
Arguments Against Audit Exemption:
- Risk of Mismanagement:
- Exemption from audits may lead to poor internal controls, increasing the risk of fraud and errors in financial statements.
- Reduced Credibility:
- Financial statements without an independent audit may lack credibility, affecting the company’s ability to attract investors or secure loans.
- Regulatory and Tax Compliance:
- Audits help ensure compliance with tax laws and regulations, which may otherwise be neglected by small entities.
- Stakeholder Protection:
- Minority shareholders, creditors, and other stakeholders benefit from the assurance provided by an audit.
- Basis for Decision-Making:
- Audited financial statements are critical for decision-making by external parties, such as banks and investors.
b. Points to Consider When Auditing Small Entities
- Nature of the Business:
- Understand the entity’s operations, industry, and key risks to tailor the audit approach appropriately.
- Simplified Accounting Systems:
- Assess the adequacy of the company’s accounting system, which may be less formalized or rely on fewer staff.
- Internal Controls:
- Evaluate the strength of internal controls, recognizing that small companies often have limited segregation of duties.
- Compliance with Laws and Regulations:
- Ensure the entity complies with relevant tax and regulatory requirements, as small businesses may lack expertise in these areas.
- Materiality and Risk Assessment:
- Adjust materiality thresholds and audit procedures to reflect the size and complexity of the entity.
- Reliance on Management Representations:
- Small entities may require greater reliance on management representations due to limited documentation or record-keeping.
- Related Party Transactions:
- Be vigilant about identifying and auditing related party transactions, which may not be formally disclosed.
- Going Concern Assessment:
- Evaluate whether the company has sufficient resources to continue operating, especially if it faces liquidity constraints.
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