The Audit Exemption: Its Role and Impact on the Quality of Accountability of Private Limited Liability Companies

INTRODUCTION

Corporate accountability can be defined as the ability of those affected by a corporation to control that corporation’s operations. The discharge of corporate accountability traditionally relied on the preparation and audit of accountability reports (financial statements). For over 100 years an audit arguably has provided a high level of assurance from an independent professional (auditor) that financial statements comply with an identified financial reporting framework and helped to enforce the obligations which are placed on companies and their directors in return for limited liability.

The financial statements of a company provide information on the financial position of a company and give an account of the stewardship of management. Such information is useful to the owners of that enterprise (the shareholders). Obviously, reliable and relevant financial statements may also provide a useful starting point for the information needs of others, such as potential investors, actual or potential creditors, lenders, employees, regulators and government. But this is debatably only ‘secondary’ in nature. It would be rare for any decision to be taken solely on the basis of information contained in financial statements.

The obligation for a statutory audit in South Africa stems from the Companies Acts, 1973 and the amendments to the Companies Act which includes Phase 1 of Corporate Law reform in South Africa – The Corporate Laws Amendment Act 2006 which requires an independent auditor to give an opinion to the members (shareholders) as to whether the financial statements “are presented fairly, in all material respects,” in accordance with an applicable financial reporting framework. The auditor does not normally assume any duty of care other than to the client’s shareholders as a body. However, secondary benefits of the statutory audit may include; Increasing confidence that filed information meets statutory requirements; Allows professional accountants to identify issues of relevance to management which can be useful in decision making; Assists companies in meeting their compliance and regulatory requirements; Can help deter fraud as the audit process is designed to give reasonable assurance that fraud and errors that may be material to the financial statements will be detected.

However, audited financial statements do not provide a ‘one size fits all’ solution to information needs. Nor are they meant to. This is particularly the case for small, owner managed, businesses (Private Companies) with little or no apparent public accountability, where the detail of financial information on the public record is quite limited due to the small company filing exemptions available under the Companies Act. While shareholders, the primary beneficiaries of audited financial statements, receive ‘full’ audited accounts, others have access only to limited information placed on the public record, and often after considerable time has elapsed between the financial period to which the information relates and when it is actually placed on the public record. While the audit adds value, there are, of course, associated costs, most obviously the cost of the audit itself. Typically, these costs are higher, proportionately for smaller companies. Such an outcome needs to be avoided not only for the sake of good public administration but for the sake of business confidence in the whole system of financial reporting. These public interest implications suggest that the interests of a company’s shareholders alone are not the only valid criteria to take into account in considering the future of the statutory audit.

This cost issue has been exacerbated with the application of a revised set of International Auditing Standards (ISAs) which registered auditors are legally obligated to comply with when conducting an audit in the manner required by the Companies Act.

This obligation stems from the newly enacted Auditing Professions Act 2006. These standards, which have been developed primarily with large, capital market companies in mind, contain a lot more detailed and prescriptive procedures than in the previous applicable South African Auditing Standards. Unlike International Financial Reporting standards which have been introduced on a compulsory basis only for listed companies in South Africa, no distinction is made as to the type and size of entity to which these ISAs apply.

During May 2004 the South African Department of Trade and Industry issued a Policy Paper indicating their intention to review South African corporate laws. The review was to include amongst others the Companies Act, and Close Corporation act, non-profit organisations and cooperatives. The reasons for the review have been stated as a need to bring South African company law in line with international trends as some of the major commonwealth countries, including the United Kingdom which recently undertook major reforms. The review was also made necessary by recent and spectacular corporate governance failures not only internationally but also in South Africa. Globalisation also influenced the decision to undertake the review. The reform was set out in two phases. The second phase of the reform takes the form of the new Companies Act that was signed by the President on the 8th April 2009 and gazetted in Gazette No. 32121 (Notice No. 421). The Act comes into operation on a date still to be fixed by the President by proclamation in the Gazette, which may not be earlier than one year following the date on which the President assented to this Act. It is anticipated a commencement date of 1 July 2010.

Despite the vital role that statutory auditing plays in enhancing trust and credibility over the financial statements of business entities, one of the most far reaching changes in Phase 2 of South Africa’s corporate law reform is the removal of the audit requirement for Private Limited Liability companies. Government’s reason for this change is the elimination of bureaucracy and unnecessary administrative requirements for small companies. Much attention has been given to removing the administrative burdens of small companies globally, as development of this sector will help grow developing economies and reduce unemployment.

Government-mandated audit requirements are believed to result in a greater level of acquisition of audit services than would occur in a free market. This may be desirable because of the nature of audit services as a public good. Without government intervention, such services may be under produced due to disagreement among financial statement users as to who ought to bear the cost of providing the service. Deregulation of a government-mandated audit requirement provides a rare opportunity to study the shift from a mandatory audit regime to a market regime. The suggestion that the increasing complexity of accounting, auditing and associated ethical standards has imposed disproportionate burdens on smaller entities and the effects of this on the cost and quality of their financial management and reporting are not clear from existing research.

Some people agree that not all companies should require an audit and are of the view that it does not make sense to require small companies to be subject to an audit where the cost of the audit outweighs any benefits. The challenge is to decide where the cut-off point should be. Others argue that all companies should be audited because there are other structures available for trading that do not require an audit.

This research paper provides a critical perspective in respect of the circumstances surrounding the deregulation of the mandatory audit for South African private companies and whether it would be beneficial for these firms to still maintain an audit of their business after the abolishment. Of particular interest is the justification for this change, the impact on the corporate accountability of private companies and whether company law regulators in South Africa have sacrificed the promoting of the public interest in favour of economic efficiency when they incorporated the audit exemption into South African company law.

A critical synthesis of the of legal and economic literature will be conducted to provide an objective discourse on the audit abolition in South Africa and what it impact it will have on the global corporate governance debate for small private limited liability companies. This research contributes to the literature on the regulation of audit services by examining the issues surrounding deregulation and the possible consequences of deregulation of such services. This critical perspective is not an effort to refute or approve the important role of Corporate Reform in South Africa; rather, it aims to illustrate various potential and unintentional effects it may have on markets, business activity, and the corporate governance debate.

The remainder of the paper is organized as follows. The next section provides a historical background for the study. This is followed by sections on the method, justification and criticism of the proposed deregulation, the impact of deregulation and the conclusion.

BACKGROUND

Background and History to South Africa’s Company Law Legislation

Company law has existed in South Africa since 1861, beginning with the Joint Stock Companies Limited Liabilities Act No 23 of 1861 of the Cape Colony, which, along with other provincial company legislation, was a carbon copy of equivalent English legislation. The first national company law was introduced in 1926 with the Union Companies Act, which was amended from time to time along the lines of the latest English legislation. The 1926 Act was replaced in 1973 with the Companies Act No 61 of 1973, which, despite efforts to innovate and develop a direction more appropriate for South Africa, remains much in the mould of English law.

The current framework of company law in South Africa is therefore essentially built on foundations, which were put in place by the British in the middle of the 19th century. The 1973 Act, hailed as cutting the umbilical cord between the South African and English company law, however, adopted many of the principles and provisions of the 1926 Act. It is therefore still based on the framework and general principles of the English law. Most amendments to the Companies Act, with the exception of the establishment in 1989 of the Securities Regulation Panel to regulate takeovers and changes of control in a company, have been of a technical nature. Thus, the last extensive reform of company law occurred in South Africa in 1973 with the enactment of the existing company law, and even then the model remained that of the 1926 Act.

When the ANC came to power it was critical of the existing legislation since it did not address the problem the major difficulties with the South African company law regime as it was highly formalistic, making it burdensome and costly to form and manage an enterprise and creating artificial preferences for certain structures.

As a result, negotiations for a new legislation commenced in 2004. During the course of the drafting of the Companies Act 71 of 2008 took place, the ANC took cognizance of the problems associated with the old Act. There was much interaction between business, labour and the government prior to the drafting of the legislation. The Companies Act 71 of 2008 has heralded a new era of corporation’s jurisprudence for South Africa.

Since the Companies Act was enacted in 1973, fundamental legal developments have taken place in South Africa. The most important change was the adoption of the Constitution in 1996. No area of South African law can be analyzed or evaluated without recourse to the Constitution, which is the supreme law of the country. The Bill of Rights, as provided for in Chapter 2 of the Constitution, constitutes a cornerstone of democracy in South Africa.

It enshrines the rights of all people in the country and affirms the democratic values of human dignity, equality and freedom. It also regulates the relationship between economic citizens and thus may have fundamental implications for company law. New company law should therefore be consistent not only with the Constitution of South Africa and the principles of equality and fairness that it enshrines, but also with other laws that have been enacted.

METHODOLOGY

Conceptual Framework

McCandless (2002) defines public accountability as the obligation to answer publicly, to report to an acceptable standard of answering, for the discharge of responsibilities that affect the public in important ways. Based on this definition McCandless (2002) developed the public accountability principle. This principal states that every responsibility that affects the public in important ways carries with it the obligation to answer publicly for the discharge of the responsibility.

It makes no sense to assign important responsibilities to corporations whether public or private and then allow them to act without attaching an obligation of answering to the public. Without answering, one is left with only fighting to stop something and/or blaming after the fact. The obligation to answer is simply an obligation in fairness - one that is reasonable to expect. The question arises as to whether this obligation to answer to the public should be a self-regulating or legal obligation.

In this respect, Singh (2007) suggests that there needs to be a robust, transparent, and efficient regulatory framework to oversee the implementation of corporate accountability. Furthermore, Singh (2007) maintains that given that there is often a considerable discrepancy between a corporations’s undertaking to act in the public’s best interest and its actual business conduct, it is essential therefore that the state assume the primary responsibility of regulating corporate behavior.

Method

This critique offers institutional critique as an activist methodology for changing perceptions. Institutional Critique is a term that describes the systematic inquiry into the workings of institutions such as the auditing profession and the investing and financial community. Since institutions are rhetorical entities, rhetoric can be deployed to change them. In an effort to counter oppressive institutional perceptions such as the audit expectations gap and audit regulation, the focus of this critique shifts from the scene of action and argument to professional writing and to public discourse using a narrative and illustrative research method. Institutional critique is a way to supplement the practice of auditing’s current efforts and to extend the field into broader interrogations of discourse in society.

This institutional critique is written in the narrative mode. The narrative point-of-view is meant to be the related experiences of the actual author. The narrative mode encompasses not only who tells the story, but also how the story is described or expressed. In this context this critique uses perspective in theory of cognition which is the choice of a context or a reference from which to sense, categorize, measure or codify experience, cohesively forming a coherent belief, typically for comparing with another. This perspective is contextual, interpretive and interdisciplinary, aiming at a more holistic understanding of audit regulation. This contrasts with much accounting research, which is influenced by an approach to economics abstracting from much of the socio-political context. The critique approach emphasizes the auditing constructs, as well as reflects individual, organizational and social reality. The aim is to contribute to an imminent critique of on the issues facing the auditing profession and their contribution to society.

DEREGULATION OF A MANDATORYAUDIT: JUSTIFICATION AND CRITICISM

Advocates of the public interest theory of regulation see its purpose as achieving certain publicly desired results which, if left to the market, would not be obtained. The regulation is provided in response to the demand from the public for corrections to inefficient and inequitable markets. Thus, regulation is pursued for public, as opposed to private, interest related objectives (Gaffikin, 2005). Davis and Ward (2008) posit the view that the public interest school holds that government actions can improve efficiency and welfare outcomes in society. South African Company Law for the 21st Century Guidelines for Corporate Law Reform (2004) was a policy paper that set out the framework and guidelines that provided the foundation for the drafting of the Companies Act, 71 of 2008. The policy paper states that socio-political and economic change in South Africa has underscored the need for social responsiveness, transparency and accountability of enterprises and that corporate law reform has been fundamental to the future of South Africa and is driven both by the new democratic dispensation. Mpahlwa (2004) argued that it was time that South Africa reviewed their regulatory framework to ensure that it was relevant for the present and the future and that it includes all South Africans by promoting economic opportunity for black businesses and small businesses.

Makatiani (2006) posits the view that the South African small and medium enterprises (SMEs) face the challenge of increasing their skills base and productivity if they want to grow into sustainable and globally competitive companies. A lack of capital and skills restricts most small local business from expanding into the export market, which results in the saturation of the local market with cheap, low quality goods and services from a range of survivalist sme-businesses. It is crucial that SMEs have systems and people in place that are efficient and productive if they want to effectively compete against larger businesses and multinationals for these opportunities. Running a small business and transforming it into a sustainable and globally competitive company is a complex undertaking in this environment.

South African entrepreneurs need to tighten corporate governance; put in financial systems and processes in place; upgrade manufacturing systems, technologies and processes; and introduce quality assurance.

The growth of the Small, Medium and Sme-Enterprise (SMME) sector is critical to the social and economic advancement of South Africa (Thabethe, 2008). Thabethe (2008) added that the development of SMMEs will continue to play a major role in empowering those who were previously economically excluded, particularly in the South African context. “Small businesses are an integral part of any healthy economy.

They enhance competitiveness of the kind that many economies sorely needs. They help to mobilise the savings from communities for productive purposes. Creating a regulatory environment in which SMMEs can thrive is crucial to long-run growth, especially in an emerging economy in which the role of SMEs is ever more vital (Davis and Ward, 2008). Irwin (2004) stated that a shift to a regulatory environment that reduces the administrative burden for SMMEs would be a positive investment in South Africa’s future. Booysen (2008) asserts that smaller companies are often eliminated from the supply chain due to the lack of funding, and corporate governance.

In public interest theory regulation is assumed to benefit society. This research contends that in terms of the legislation as set out in the Companies Act, 71 of 2008, SMEs appear to be the forgotten stakeholders in the fair and efficient management of South African corporate governance because the Companies legislation perpetuates the myth that the corporate governance market is essentially aimed at listed and other public companies. It can be speculated that rules, norms and best practice in corporate governance for SMEs will somehow magically trickle down to SMEs. The Companies Act, 71 of 2008 offers neither resources nor practical guidance on corporate governance for SMEs.

An alternative view could be that that the South African government does not consider that corporate governance should apply to SMEs due to the cost associated with implementing corporate governance e.g. appointment of independent directors, developing internal control systems and external audits. The statutory audit for an SME provides no added value for a company and the sooner it is abolished the better. There is a risk that a message will be sent out to small companies that the authorities will not be concerned about the quality and reliability of the accounts that they prepare.

The limited liability company is an important business entity in a modern economy. Under this structure, entrepreneurs can conduct business with limited risk to their personal assets in the event that the business proves unsuccessful and does not generate sufficient funds to meet all its liabilities. The limited liability structure represents a major concession by society generally to entrepreneurs, because it enables them to take risks that they might not otherwise be prepared to accept. The reason society is prepared to convey this concession is because it facilitates greater economic activity, which in turn increases the wealth of society generally.

However, the operation of limited liability companies carries an increased risk of default for anybody dealing with such companies, because once the resources of the company itself are exhausted, there is no further recourse for any debts owed.

Thus, society does not allow unfettered use of the so-called "corporate veil" and prescribes rules under which those wishing to avail of it must operate. In South Africa’s case, these rules are set out in the Companies Acts and elsewhere and are designed to ensure that the owners of companies behave in a responsible manner and do not attempt to take advantage of the privileged position which limited liability status affords them.

The primary purpose of regulation in any economic sector is to provide, for reasons of public interest, a counterweight to free market forces and to counteract market failure. If allowed to operate unchecked, these forces may merely serve to benefit individuals in society to the disadvantage of society as a whole. Reports by auditors on financial statements are widely used for decision-making in our economic lives. Reliable and respected financial reporting and audit are fundamental elements in supporting the reputation of South African business, in avoiding financial losses, in encouraging trade and ensuring the efficient operation of the South Africa financial markets and more generally, in enhancing the attractiveness of South Africa as a location of business development.

This process of simplifying company law in South Africa will result in private limited liability companies not being required to prepare financial statements or to appoint an auditor. The impact of the company law “simplification process” guarantees that small closely-held private companies have been overlooked in the fair and efficient management of South African corporate governance. The adoption of limited liability status by individual companies must be counterbalanced by a proportionate requirement for public accountability and transparency on the part of the companies concerned, and the new corporate law regime will provided a little or no confidence to employees, shareholders, creditors and prospective suppliers that a company is operating in accordance with corporate governance rules, norms and best practice.

For the privilege, of limited liability an entity must ‘pay’ by making information available to its stakeholders in a responsible, transparent and unbiased manner. Gone are the days that a company is only accountable to its shareholders. No company is an island. It is part of a complex infrastructure and as a corporate citizen, is accountable to the community, employees and others. The owners and directors of private limited liability companies must be made accountable in law for their actions. The law should ensure that external stakeholders, such as shareholders, minorities, employees, creditors, suppliers, consumers and the general public, are protected.

The question arises – if there is no corporate governance function in private companies how are the stakeholders protected from irregularities committed by the company? There are many of laws that define what a company may do and may not do. These laws are framed to control company behaviour so that they behave in a way that is consistent with the public good or at least that is the theory.

The whole nature of the law is to provide checks and balances to try and keep the behaviour of companies under control so that it does not disadvantage any other group in society. There is a particular problem with financial matters as many members of the public do not understand how the financial world works but need to be able to invest in financial products with confidence without having to spend all their time checking up on the companies.

Company law should therefore contain a minimum of mandatory rules and clear and enforceable prohibitions, limited to those aspects of corporate structure, governance, administration and management which must be complied with by all companies so as to ensure transparency, disclosure, the protection of legitimate interest and the prevention of fraud and improper and oppressive conduct (South African Company Law for the 21st Century Guidelines for Corporate Law Reform, 2004).

This raises the question as to why a certain group of companies should not be required to be audited. The audit of small companies is a very important element of corporate governance (Williams, 2008). With the benefits of trading in a corporate structure, for example limited liability comes with certain responsibilities.

The obligation to provide reliable information that has been audited by an independent professional is one of those responsibilities. An audit provides a high level of assurance from an independent professional (auditor) that financial statements comply with an identified financial reporting framework. It therefore adds to the credibility of financial reporting (Rezaee, 2004).

An audit performed on the financial statements of an SME benefits the SME in many ways. For any organisation to prosper, it is essential that proper and reliable financial information and sound corporate governance are in place. An audit helps protect the interest of stakeholders and provides a level of comfort to key decision makers, allowing them to know that the financial information they are using for their business decisions are reliable and comply in all material aspects with the relevant accounting framework. With good corporate governance and sound financial reporting processes, corporate accountability is enhanced, which eventually leads to the creation of wealth for stakeholders.

Audited financial statements prepared in compliance with accounting standards provide more transparency to investors, suppliers and financial institutions on a company's financial position. In some situations, financial institutions or investors may see businesses that have not been subject to external audits as having higher a default risk, hence restricting their access to credit, which may impede expansion.

The benefits for SMEs of having their financial statements audited so that these are properly prepared in compliance with the relevant accounting framework are tremendous. Such financial statements, if used appropriately as the basis for tax computation and tax filing purposes, will minimise the likelihood of the companies filing inappropriate tax returns that could result in unnecessary tax penalties and interest.

It is common for SMEs to be family-managed companies, with key management positions held by family members. Sibling rivalry and conflict of interest are common in family-managed companies where management and control are ineffective. An independent auditor could be engaged to highlight whether financial information and controls are credible and reliable. This could also act as a deterrent against fraud and misappropriation of funds in family-managed set-ups. Recommendations by external auditors, if properly implemented by management, can improve internal controls, leading to a stronger controlled financial structure that reduces the opportunities for fraud.

Consequently, an audit provides a platform, both financial and non-financial, for SMEs to build on to meet future challenges. Having an audit performed on its financial statements will prepare an SME for greater challenges as it grows and develops into a more complex organisation, especially if it is a potential candidate for expansion or a listing.

The advantages of engaging an external auditor to audit financial statements far outweigh the cost of not having one, since auditors play an important role in the success and growth of a company - more so for an SME that is expanding rapidly. An objective assessment by qualified professionals of an entity's accounting and internal control systems will prevent unforeseen problems.

Business and their stakeholders need to rely on credible information to make effective economic decisions and for business relationships to work effectively. For information to be credible, it needs to be objective, of good quality and fit for purpose. Trust and integrity are important factors that underpin credible information flows. It is however, difficult to build trust in a complex and dynamic business world where there are new technology and business practices, changing expectations of stakeholders and demands for further information and a stream of new regulations which require increasing levels of expertise and experience.

Business and their stakeholders need suitable solutions to help address these issues and meet their information needs. One of these solutions might be external assurance. External assurance may be described as the provision of an independent opinion provided by an expert practitioner on information prepared by business for the benefit of stakeholders. It is important to emphasise the point that the opinion comes from an independent source. Stakeholders want credible information that they can trust. Objectivity and independence are therefore essential characteristics of external assurance.

Reducing compliance costs for the company can only become a convincing argument for deregulation if the reduction in compliance is not to the detriment of those who stand to benefit from the compliance work and for whose benefit the accountability measures are intended in the first place. Thus, the merits of the Companies Act 71 of 2008 must be assessed by reference to the damage that they could incur to the interests of stakeholders. One question raised in this discussion is whether the level of assurance provided an audit should be the same for all types and sizes of clients, or should the concept of reasonable assurance mean that an auditor can provide a lower level of assurance for non-public interest entities such as SMEs.

The Companies Act 71 of 2008 provides that certain private companies, for example non-owner managed companies, may choose to either have their financial statements audited by a registered auditor or have their financial statements independently reviewed. This would result in two levels of assurance: reasonable and limited. Only a limited level of assurance would be given by the review that the financial information subject to review is free material misstatement. The assurance report would provide negative form of assurance.

Tabone and Baldacchino (2003) findings indicate that in the context of owner-managed companies, the statutory audit fulfils two important roles. First, it is relevant to outside third parties who have no direct ownership interest in the company but who nonetheless contribute to the viability of the enterprise. Second, it has a positive effect on the owner-manager and staff. The auditor may also fulfil a behavioural role, acting as an influence on the directors, management and staff. The auditor may assist the directors in maintaining a company's reporting standards and grant the directors access to financial expertise to improve their existing systems and controls. Thus, the question arises as to whether a mandatory annual statutory audit requirement is justified in such circumstances, where the auditor is merely reporting information already known to the same person acting in a different role.

Crous (2008) argues that one of the biggest questions currently facing South African companies is whether the audit of financial statements is a necessity or a luxury which few can afford. This argument is based on the ever- increasing inflation rate, interest rate hikes, spiraling fuel prices, electricity rate hikes and the weakening exchange rate, the pressure on the financial resources of companies is tremendous, and the questions that most shareholders and directors of companies are asking is where to cut costs, by distinguishing between the necessities and luxuries. For several years now audit firms have heard about complaints regarding the fact that the audit report for a private company is a luxury which only consumes valuable financial resources, and that the benefit derived from these reports does not equal the cost and time spent.

While the reduction of business costs is definitely a worthwhile aim, which should be pursued, it must not be seen as an end in itself. Simply achieving cost reductions would not be a satisfactory outcome if the other consequences for companies included lower standards of financial management, higher rates of insolvency and resulting loss of jobs, and a higher risk of financial crime in the SME sector. It is essential that the merits of any possible changes in the areas of company law, accounting and auditing be assessed not solely from the perspective of how much money abolition would save for the individual company but by reference to the wider context of costs and benefits, both for the company, its stakeholders and the public interest generally.

External audit reinforces sound financial management and corporate governance - which are both essential to a company's health. Many companies will choose to take advantage of audit exemption on the grounds of cost alone, and will not replace the audit with other services from professionally qualified practitioners. They will, therefore, lose the advantages which audit brings, and it is widely accepted that inadequate financial management is a major element in small company failure. The cost of audit is small compared to that of other statutory regulations bearing on small companies. In contrast to external audit, few of these regulatory burdens bring direct or indirect benefits to the companies themselves.

Many small, local practices which have provided the bulk of accountancy services to small businesses may, over time, cease to carry out audit work. This will reduce choice severely for those small entities which retain the audit on a voluntary basis.

It is accepted that the audit imposes some indirect costs in addition to direct costs, such as: the cost of the bank letter and other 'certificates' required by auditor from third parties and the time cost of staff dealing with audit queries and explaining accounting and related systems to audit staff. There is general acceptance of the argument that the credibility of the audit report to non-member readers suffers to some extent because of the long delay between the accounting year-end of a small company and the time of its audit. SMEs may not always have the necessary internal resources or expertise to ensure compliance with the Financial and Reporting Standards or keep up with changes in them.

The benefits of an audit are hard to appreciate while the costs are fairly straightforward according to discussions with many directors of small business. Further, they reveal that auditing principally arose due to owners’ aspiration of an independent review of their firm. In small limited firms, the owner is usually the one who runs the firm. In this case, auditing is mostly useful for stakeholders such as, banks, suppliers, tax authority, despite that the cost of auditing is only on the firm.

Directors of small business disagree with the notion that small limited firms are facilitated in acquiring loans from banks as a result of auditing. This is since they imply that banks can receive the necessary information from other sources.

CONSEQUENCE OF DEREGULATION

After the abolishment the Government will no longer act as the head principal that requires auditing, such that auditing will no longer be law regulated. Instead the role of the principal will shift to other stakeholders, which may require that a firm’s annual reports are audited before developing an exchange relationship with them. Auditing may facilitate granting of loans, longer credit periods and loyalty, a credible image of the firm, as a result of business owners providing trustworthy information to the stakeholders. Furthermore, by taking these benefits into consideration, a firm is able to determine whether the benefit of auditing exceeds the cost.

In some cases, auditing may not be considered necessary to maintain. This could be the case in sme firms for instance, despite the benefits discussed. This is could be such that there may be a lesser need to get access to financial information in order to control the performance of the management. Since sme firms usually comprises of only one owner who also is the manager of the firm, and the only worker, s/he thereby already possesses all information concerning the business. Moreover, if a firm already has an established circle of customers, they will, as long as they are content with the experienced exchange relationship, probably not pay attention to whether the business owner maintains audited reports of his/her business or not. On the other hand, it is beneficial to maintain an audit to gain the trust of new circle of customers. However, it is beneficial for small firms, to maintain an audit of their business. This is because, such firms are large enough to benefit the by products that auditing yields.

One can easily present and demonstrate the advantages respectively the disadvantages of auditing; yet, it is difficult to generalise an individual firms’ need of reviewing their businesses.

Instead, each firm should take into consideration the pros and cons of auditing that are applicable to their business and thereby decide whether to maintain or exclude an audit. However, by realising the importance of auditing, reveals that being a means of revising annual reports, it assures that the firm’s financial information is reliable and trustworthy. Getting an audit of the business enhances a firm’s reputation. A firm gains credibility and assurance of quality through auditing. This is indeed, one of the main grounds for upholding such routine, after the abolishment. Nevertheless, it can be concluded that it is beneficial for small limited firms to maintain an audit of their business, despite the abolishment of statutory audit, to uphold a credible and trustworthy external image of the firm.

CONCLUSION

This is a very difficult issue. South Africa is caught in a position in which there are conflicting

forces. On the one hand, businesses are screaming for relief from the massive regulatory burdens being placed on them. Also, if the South African economy is to grow at a reasonable rate, barriers to small business need to be reduced to a minimum. In addition, South Africa needs to retain its competitiveness in the international arena to attract foreign capital. On the other hand, regulators have difficulty in doing their job without some assurances. Relaxation of audit could also hamper skills development.

Although regulation often corrects market failures or promotes the public interest, it is important to realise that there may be a trade-off between these goals and economic efficiency. Hence, overbearing regulation can diminish competition and hold back entrepreneurship. Therefore, the impact of new and existing regulations on businesses – especially SMEs – needs to be considered thoroughly. In theory, as competition is eased, there are deleterious effects on economic efficiency. Reduced competition is likely to lead to greater price cost margins as incumbent firms have greater market power, reducing allocative efficiency.

It is also likely to lead to a reduction in productive efficiency; firms’ utilisation of inputs is improved by greater competitive pressures impacting on workers and managers. Finally, reduced competitive pressure will have an effect on long-run dynamic efficiency as there will be lower incentives to innovate.

The questions arise – Will the SME industry collapse based on the premise that an audit is an expense that has been perceived to be unaffordable and a regulatory burden? Will company law be brought into the 21st century simply by removing the audit of a SME limited liability company?

Everyone would agree that companies do contribute to people’s prosperity and overall wellbeing. But, too often, companies also cause harm to communities, damage the environment, or violate workers’ rights in the course of doing business. This is because company directors’ desire to operate to high ethical and social standards are often outweighed by their obligations to their shareholders, whose interests take legal precedence over employees, communities and the environment.

Limited liability means that the power of a company's owners is not matched by any responsibility because the law puts them beyond the reach of their fellow citizens. This immunity provides shareholders with the greatest regulatory protection granted to one section of society by the state. Is this fair and equitable and in line with the Constitution of South Africa?

Law and regulation play an important role in promoting ethical behavior. This is particularly so where the legal and regulatory system governs business conduct, as much of that conduct is sufficiently new (relatively speaking) or complex that its propriety cannot be determined by resort to traditional ethical precepts. The importance of law and regulation to business ethics is greater still where the focus is on the conduct of organizations (typically corporations) as opposed to individuals. Consensus does not exist on how conventional notions of actions and intentions – key to ethical theory generally – should be applied to organizations.

The concatenation of these two factors – the need for law and regulation to articulate standards of ethicality in business matters, and the inherent difficulty of determining by what thoughts or deeds a corporation should be judged – places a heightened burden on government to articulate the steps that corporations should take to require proper behavior and corporate social responsibility.

Until a couple of decades or so ago, in order to discharge their accountability, corporate managers were required to produce accountability reports in the form of annual financial statements and to submit these to independent (external) audit. However, since the 1970s, the extent and severity of the impact of unexpected corporate failures, and revelations of instances of misconduct and reckless management by senior company officials, have demonstrated that the twofold approach to securing corporate accountability is inadequate.

Initially, attempts were made to strengthen the external audit function by means of establishing audit committees comprised of non-executive directors. However, unexpected corporate failures and revelations of misconduct by corporate officials continued and, since the early 1990s, it has been recognised that an additional element is needed to secure the accountability of corporate managements – that of responsible corporate governance. This development seems to mark a move to a new stage in the corporate accountability arena, one in which the central role is played by external auditors, internal auditors and the audit committee.

The three forms of assurance (external auditors, internal auditors and the audit committee) cannot as a group apply to SMEs, however the legislature should consider some form of compulsory external assurance for the SME - it is in the public’s best interest.