Red tape around audit is proving hard to untangle

THE Department for Business, Innovation and Skills (BIS) has published proposals to reduce financial reporting requirements for small and medium-sized enterprises (SME) and subsidiaries.

EU rules mean that to classify as small for accounting purposes, a company must comply with two out of three criteria: gross assets of no more than £3.26m; turnover of no more than £6.5m and fewer than fifty employees. In the UK, however, to obtain an audit exemption small companies must fulfil both the balance sheet and turnover criteria. Under the new proposals, UK SMEs would be eligible for audit exemption by meeting any two of the three criteria, saving them an estimated £206m per year. BIS is also proposing to introduce legislation in 2012 to exempt most subsidiary companies from mandatory audit, provided the parent is prepared to guarantee debts.

The amendment to the audit exemption for UK companies brings the audit requirement into line with the criteria for filing and disclosure purposes, so it is a useful simplification of the rules. If the quoted figures for savings are correct then the change is certainly welcome. But it is to be hoped that banks and other finance providers follow suit. More often than not, small companies are required by their banks, as part of borrowing covenants, to have audits. This could render any regulatory changes inconsequential.

The change for subsidiaries is less clear. The condition that the parent should guarantee subsidiary company debts takes away a key rationale for keeping separate trades in subsidiary companies. The conventional view is that trading in different businesses should be run through subsidiaries and any surplus profits transferred up into the holding company. In this way, the holding company can accumulate reserves and if the trading subsidiary suffers a misfortune, the surpluses are protected in the holding company. If the subsidiary starts to incur losses, or ends up in a risky business, the holding company is insulated from any adverse consequences. This is the benefit derived from such a structure. Few holding companies, having set up this structure, will wish to then step in to guarantee the debts of their subsidiaries – it defeats the object of the arrangement.

Barnes Roffe researched the guarantor arrangements of 100 subsidiary companies spread across 34 groups in London and the South East. None of the groups had in place cross guarantees for general creditors and only 14 had arranged guarantees for subsidiaries’ bank borrowings. Twenty groups, or 68 per cent, offered no guarantees of any kind.

It is therefore probable that many group holding companies will prefer to retain audits for subsidiaries rather than enter into general guarantees.

The move to cut red tape is great and we need more, but not if every effort to reduce bureaucracy has self-defeating conditions.

Mario Cientanni specialises in mergers and acquisitions. He is a partner with Barnes Roffe.