Time to raise the charity audit threshold?

The audit profession has had a hard time keeping out of the media in recent years. Well-publicised corporate failures such as Carillion and Patisserie Valerie have contributed to a loss of public trust in external audit, whether fairly or not, and governments and regulators have responded with significant increases in standards and oversight.

Whilst some accounting firms have chosen to withdraw from providing statutory audit services, those firms where audit represents a key element of their business have responded with investments in people, processes and technology. This investment has led to fee increases to reflect the greater levels of work taking place.

Charity audit thresholds have remained unchanged since 2015 requiring charities with annual income in excess of £1 million, or income of more than £250,000 and gross assets of more than £3.26 million, to have a full statutory audit. Charities below that size are subject to Independent Examination – a far less rigorous and more limited form of scrutiny which in some cases does not even need to be carried out by a qualified accountant.

Recent Charity Commission statistics show that around 8,700 out of 170,000 registered charities (5.1%) are above the audit threshold, with 5,748 (3.4%) falling within the annual income band of £1-5 million.

The Institute of Chartered Accountants in England & Wales (ICAEW) has recently written to the Commission to express support for a consultation on raising the current audit thresholds. The letter cites three key reasons:

• An increase in the current thresholds, so removing the audit requirement from even more charities, would be in line with the Commission’s 5 years strategy which emphasises the need for proportionate and effective regulation
• The effect of recent high levels of inflation is to drag many smaller charities towards current audit thresholds at a time when they face other financial pressures
• The audit profession is facing increased demands in other sectors (including the audits of public interest entities and local authorities) and the requirements of regulators and standard-setters have grown more exacting in recent years. Combined with relatively low recruitment into the profession during the Covid years, this leads to capacity and cost pressures within the audit profession which are having a knock-on effect on charities

The key points in the letter about the increasing cost of audit and the relative scarcity of auditors are echoes of the 2023 charity audit survey conducted by Charity Finance magazine. That survey noted that audit fees were increasing, but still represented just 0.1% of income for audited charities on average so a relatively tiny percentage of the overall cost base. Respondents also acknowledged that increases in the technical quality of auditing was exactly what the audit regulators had sought to achieve, and that it was inevitable that higher quality would come with higher cost. At the same time less than 50% of charities cited technical competence as an important factor when selecting an auditor, whereas over 60% cited fees. This suggests that the majority charities are prioritising fees far more than audit quality which does not make an appealing prospect for an audit firm.

The issue that is not referred to in the ICAEW’s letter, perhaps surprisingly, is the value of audit to the charity. A high quality audit will help the Trustees fulfil their legal obligation to prepare accounts which show a true and fair view and are in line with the charity SoRP and other key regulations. At a time when accounting standards are increasing in complexity, and with a new SoRP on the horizon, this is an important consideration for Trustees. Audits can also help detect irregularities, or fraudulent activities within a charity’s financial records. Charitable status brings many benefits to an organisation such as the ability to raise funds from the public and a tax exemption on most activities, and it is sensible that these benefits attract a ‘price’ of higher scrutiny and transparency. Finally, many charities report an ‘audit premium’ where large grant givers explicitly require audited accounts as part of funding applications and monitoring reports, so charities where that is a crucial source of income may still commission an external audit even where one is no longer required.

It remains to be seen whether the ICAEW’s contribution starts a broader debate on the role of financial audit within the sector, and how an appropriate balance of cost and rigour can be achieved.

To discuss this in further detail, please speak to one of our Charities and Education Team members.