Subsidiary audit exemption – four things to consider

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There are various requirements for a subsidiary to become exempt from audit under recently published legislation; these most significantly include a statutory guarantee to be given by the parent company of all of the liabilities of the subsidiary at the financial year end.

I believe that taking advantage of the exemption will require careful consideration.  Here are four things to consider:

Be sure that you understand the exposure under the guarantee.   

A liability can be defined as “an obligation to transfer economic benefits as a result of past transactions or events” (source FRS 5).  I am no lawyer, but I would suggest that the liabilities being guaranteed may not just be the ones included in the balance sheet.  If there are contingent liabilities such as a trade claim that have been merely disclosed in the accounts – I would suggest that they could well fall within the guarantee.   Events that give rise to liabilities can have a slow burn (for example environmental claims) and one can envisage that the question “how far does the guarantee extend?” will be ripe for clarification in the courts.

In any event directors will need to consider whether the granting of a guarantee is in the parent company’s interests. To do this I suggest that they will need to understand the liabilities in the subsidiaries being guaranteed and this may mean relying on local management – perhaps in a background of reduced (or even no) independent scrutiny.

Might you be selling the subsidiary?

If a subsidiary is sold, the responsibilities under the guarantee will stick with the parent company.   While the majority of liabilities at the end of the last financial year may have been discharged, there could be contingent type liabilities that are around for some time.

While it may be possible to obtain a counter guarantee from a purchaser; it could make for interesting negotiations and could even come at a price!  Furthermore if the purchaser and subsidiary go out of business then the original parent company will still be in the firing line.

Does the subsidiary have minority shareholders?

…perhaps you can obtain a proportionate counter guarantee.  (I am grateful to David Young of Audit Review for pointing this one out in his technical note on the audit exemption legislation).

I think that this is worth exploring, although I can see that minority shareholders not involved in the management of the business may be reticent.   The perspective of management minority shareholders may also prove interesting!

Perhaps it is beneficial to have an audit

Subsidiaries that are exempt under the rules will part of a group that will still need to be audited.

To what extent will the exempt subsidiary still be audited?  The smaller it is (in the context of the group) then the more likely it is that it will fall the auditors’ radar.  (However in some groups “small” in this context may include substantial businesses!).

If the subsidiary is exempt then what independent scrutiny will it receive?   While perhaps contrary to the general tide of opinion, I am sceptical about the merits of widening audit exemption; external audit does have benefits, especially when stakeholders are not involved in the business.   I recently wrote a blog on the subject:  Is more audit exemption a good idea?

However, if groups do want to go down the audit exemption path then it may be worth considering the extent of internal audit resource (even if it has a different focus to statutory audit).

The legislation is only effective for financial years ending on or after 1 October 2012.  It is early days and the implications need to be more fully thought through… I would be really interested to hear your views.

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Comments

  1. This will change risk profile management in lending departments for all lenders.

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