Due to small firms’ heterogeneity, the benefits of an audit are not as clear as they are in the case of public companies, an understanding which is reflected in the absence of worldwide consensus regarding statutory audit requirements for small firms. To shed some light on the costs and benefits of an audit on small companies, this study investigates the voluntary audit decision in Germany based on a random sample of 405 small firms responding to a postal questionnaire survey.
Institutional and Regulatory Setting
Member States of the European Union have to comply with Directive 2013/34/EU audit regulation, which requires limited liability companies that are medium-sized, large or of public interest to have their accounts audited by one or more approved statutory auditors. Consequently, those companies that qualify as ‘small’ are not explicitly required to have an audit. However, Member States can impose an audit on ‘small undertakings’ that takes into consideration the conditions and needs of those companies, as well as the users of their accounts. Accordingly, different audit exemption regimes can exist within the European Union depending on Member States’ choices and definitions of ‘small undertakings’.
In contrast to other EU countries such as Sweden, Finland or the UK, Germany has always used the option to exempt small companies from statutory audit requirements and has always set the thresholds for ‘small’ companies at the EU maximum. Currently, companies are classified as small according to § 267 (1) of the German Commercial Code (HGB) if they do not exceed two out of three size thresholds in two consecutive years (total assets: 6,000,000 €; turnover: 12,000,000 €; average number of employees: 50).
Summary of Results
In Germany, the proportion of firms opting for voluntary audits is extremely low compared with voluntary audit ratios documented in other countries. While we find that only 12 per cent of the companies investigated opt for voluntary audits, the equivalent ratios found in other countries ranges between 26 per cent and 80 per cent. One reason for this considerably different result in the case of Germany may be its lack of a mandatory audit history for small companies. Since previous practices are most likely to influence cost benefit perceptions, managers from Germany may value the costs and benefits of voluntary audit differently to managers from countries with a history of previously mandatory audit regimes.
In line with previous research, we find that the likelihood of an auditor being hired voluntarily is correlated with the proportion of company owners who are not involved in management as well as the importance that managers place on accounting information for management accounting purposes. In contrast to previous studies on voluntary audit, we do not find that the status as a family firm, ownership dispersion, or leverage (total debt divided by total assets) impacts a firm’s voluntary audit decision. However, extending previous research, we do find evidence that the legal form in which a company operates, the status as a subsidiary, and outsourcing of accounting tasks are further factors impacting a manager’s voluntary audit decision. However, we cannot provide support for the argument that the existence of a supervisory board increases the likelihood of a voluntary audit.
By further examining the professional qualifications of those to whom accounting tasks are outsourced, we provide evidence that the employment of an external tax advisor decreases the likelihood of a voluntary audit. In contrast, if accounting tasks are outsourced to an external accountant having the qualification of an auditor the likelihood of a voluntary audit increases. Subject to the professional qualifications of those to whom financial accounting tasks are outsourced, this result suggests that auditing can play a substitutive or a complementary role.
Overall, the study helps to understand the role played by financial statements and auditors in private companies. Germany provides a very different institutional setting than exists in other countries due to its historical lack of a mandatory audit for small companies. Consequently, the German setting can provide answers to the question of what ultimately may happen in those countries that increase the number of companies which are no longer mandated to undergo a statutory audit.
The findings of this study may encourage further discussion regarding the necessity of statutory audits in private companies across Europe. Moreover, it serves as a basis for further discussions and research regarding the costs and benefits of audited financial statements in the case of private firms.
Interested readers can download the full study free-of-charge by clicking the following link: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2916688.