The Companies Act 2016 which came into operation on 31 January 2017, requires all companies to prepare and audit their financial statements before lodging it with the Companies Commission of Malaysia (SSM). However, under section 267(2) of the Companies Act 2016, the Registrar of Companies can exempt selected categories of private companies from having to appoint an auditor and to impose the criteria and conditions accordingly.
To this end, on 4 August 2017, SSM issued the Practice Directive No. 3/2017, highlighting that dormant, zero-revenue and threshold-qualified private companies are eligible to elect for audit exemption.
A dormant company qualifies for audit exemption if it has been dormant from the time of its incorporation; or it is dormant throughout the current financial year and in the immediate preceding financial year.
A zero-revenue company is qualified for audit exemption if it does not have any revenue during the current financial year; it does not have any revenue in the immediate past two financial years; and its total assets in the current Statement of Financial Position (FS) does not exceed RM300,000 as well as in the FS of the immediate past two financial years.
A threshold-qualified company is qualified for an audit exemption if it fulfills the following criteria-
- It has revenue not exceeding RM100,000 during the current financial year and in the immediate past two (2) financial years;
- Its total assets in the current Statement of Financial Position does not exceed RM300,000 and in the immediate past two (2) financial years; and
- It has, at the end of its current financial year and in each of its immediate past two (2) financial years’ end, not more than five (5) employees.
Small and medium enterprises (SMEs) have been exempted from mandatory audit in many countries such as Singapore, United Kingdom, Hong Kong, Australia, New Zealand and United States. In Australia exemption of audit was introduced since 1971, Canada and UK adopted audit exemption in 1994. Singapore adopted Australian’s approach in 2003 with qualifying threshold being reviewed in several stages through the years.
Whilst SSM understands the importance of auditing company accounts in promoting accountability, accuracy and transparency, there is also a need to revisit the value and necessity of an audit towards balancing between the needs of the company and that of its stakeholders.
It is an undeniable fact that the majority of small SME companies are ‘owner-managed’ or “family-run businesses” where the shareholders and directors are typically the same individuals. For these small SMEs, due to the unique structure of its business model, the costs for a conventional audit mandated by law which provides negligible value added to its business may not be a justifiable cost.
Moreover, under section 266 of the Companies Act 2016, an auditor is responsible to report to the shareholders on the financial statements prepared by the directors but the value of the audit report will be insignificant where the shareholders themselves are also managing the company as directors.
As highlighted in the auditors’ report, the report will state that it is made solely to the shareholders of the company and for no other purpose. The report will also include a disclaimer that auditors do not assume responsibility to any other person for the content of his report. Hence, the audit report is not meant for external stakeholders like financial institutions and investors (existing or potential). These stakeholders could always request the company to furnish audited financial statements should the need arise. In other words, it is not justifiable that mandatory audit requirement which was meant for internal consumption of shareholders of a company to be extended to third parties.
Independence examination of the financial statements is the primary justification of an audit and therefore is the hallmark of the auditing profession. It is recognized as the key qualities adopted and preserved by auditors under all circumstances and is fundamental to public confidence in financial reporting. Over the years, the relationship of auditors of a small and medium practice (SMPs) firm with their clients would have reached a stage where some auditors are also acting as ‘expert advisors’ to support business activities of the SMEs in addition to providing a statutory audit. These “advisory” roles may have led to conflicts because auditors have to maintain their independence of their clients while at same time addressing the advisory needs of their clients.
In a hindsight, the potential advantages of audit exemption would include allowing SMPs to focus their resources in developing their professional capacities and capabilities in niche areas of expertise rather than performing statutory auditing to serve the mixed categories of SMEs segments. SMPs with the ability to provide SMEs with a diverse range of business advisory services and expansion of such services beyond the traditional mandatory audit work will be a catalyst for growth in both entities resulting in a crucial “win-win” relationship between the SMEs and SMPs on a long term basis.
In the Report on The Observance of Standards and Codes (ROSC) published by the World Bank in February 2012 on Malaysia, showed that due to the high ratio of the number of statutory audits required in relation to the number of auditors and coupled with the skill and capacity shortages in relation to staffing within the auditing professions, the quality of audit could be below the acceptable level set by the International Standards of Auditing (ISA) adopted by auditors globally. There are also many auditors struggling to understand the increasingly complex and prescriptive audit standards (including ISQC1 and key-audit matters). In Malaysia, similar auditing standards are adopted by the Malaysian Institute Accountants (MIA) which regulates the conduct of its members.
This finding is supported by the review conducted by MIA on audit firms in 2016 with respect to auditors’ compliance with auditing standards where only 7% of the firms reviewed falls under Type 1 (Satisfactory), 45% is under Type 2 (Assurance of Compliance) and the balance 48% falls under Type 3 (Follow-up).
A Type 1 audit firm is considered to have satisfied all key elements to maintain professional standards but with possible further improvements to its internal quality control systems whilst a Type 2 audit firm requires MIA to follow up after twelve months (or earlier) about the progress of the rectifications on its shortcomings.
However Type 3 is where 48% of the audit firms are positioned and its key audit deficiencies are likely to materially affect the overall quality of an audit engagement. A normal full scope second review is required to ensure that the recommendations made for the improvement of audit quality have been implemented.
In summary, only 7% of the audit firms reviewed met the Type 1 criteria and 93% of the audit firms require rectifications on its audit procedures. The low 7% audit firms under Type 1 could be due to the estimated 1,500 audit firms servicing about 773,651 companies requiring mandatory audit.
The rationale for the criteria adopted by the Registrar in exempting audit is based on the approaches that comprised a combination of both economic structure and size of leading jurisdictions which have successfully implemented audit exemption policy in addition to the consultation conducted by SSM for four months ending 28 February 2017. Feedbacks from stakeholders comprising 61% audit/accounting/related professional firms and 39% from the public, showed that more than 65% of the respondents agreed with the audit exemptions proposal.
Additionally, the criteria adopted by the Registrar is also coupled with safeguards of allowing shareholders holding not less than 5% of the total voting shares to require the company to have its accounts audited. On top of that, the Registrar is also given the power to direct companies to have their accounts audited.
For companies electing for audit exemption, companies are required to lodge a full set of an unaudited financial statements accompanied with a statement that the company is qualified for audit exemption and that the company receives no request from its shareholders that audit must be conducted for a particular year.
SSM reiterates the importance of keeping accounting records and preparing financial statements in compliance with approved accounting standards as required under the Companies Act 2016 and all companies are required to comply irrespective whether they qualify for audit exemption or otherwise. Furthermore, with the implementation of XBRL format of reporting for financial statements with taxonomy created by SSM based on the Malaysian Financial Reporting Standards (MFRS) and Malaysian Private Entities Reporting Standards as issued by MASB under the Financial Reporting Act 1997, financial statements prepared by Malaysian companies will comply with the required accounting standards. The XBRL reporting platform will be implemented in the second quarter of 2018.
“Financial statements are still required to be prepared by all companies and these must be prepared in accordance with the approved accounting standards, hence the dispensation of audit will not undermine the quality of financial statements prepared. As such, the Parliament has exercised its wisdom when passing the law which allows audit exemption for certain categories of private companies and therefore, the parameters of audit exemption should be where there are minimal risks of fraud coupled with appropriate safeguards for shareholders’ protection. With regards to lodging financial statements which are fraudulent, section 593 of the Companies Act 2016 makes it an offence and prosecution action will be taken against errant companies and directors for lodging false and misleading statements to the Registrar,” says Dato’ Zahrah Abd Wahab Fenner, Chief Executive Officer of SSM.
“To this end, SSM has been vigilant and conducted continuous enforcement as reflected in the number of cases with respect to fraudulent information lodged with the Registrar. For this year alone, as at 30 June 2017, a total of 189 investigation papers have been opened, 32 cases have been concluded and 4 cases have been prosecuted,” she adds.
COMPANIES COMMISSION OF MALAYSIA
18 August 2017