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The accounts and audit provisions of Companies Act 2006 are applicable in respect of financial years beginning on or after 6 April 2008. Amongst other things such provisions outline the conditions for a company or a group to qualify as small and the separate conditions for a small company to be exempt from audit.

Under the Companies Act 2006 the criteria for a company or a group to qualify as small or to claim audit exemption are not materially different from those contained in Companies Act 1985, except for the fact that under the new Act the size thresholds have been increased by 20% across the board and that the provisions are worded and laid out in a more comprehensible manner.

Non-group companies qualifying as small and exemption from audit

Section 381 of Companies Act 2006 states that the small companies' regime applies to a company for a financial year in relation to which it qualifies as small and it is not excluded from the regime.

In respect of companies that are not part of a group the qualifying conditions are outlined in section 382 of the Act.

To qualify as small a company in its first financial year needs to meet at least two out of three of the following conditions:

• turnover not more than £6.5m
• balance sheet total not more than £3.26m
• number of employees not more than 50.

In respect of subsequent years the company will only incur a change in its status, e.g. from medium to small or from small to medium, if it respectively meets or fails two out of the three above conditions for both the current and the preceding financial year.

The above is commonly referred to as the two-year rule and its tenet has remained unchanged from the provisions of the 1985 Act.

It is important noticing though that the increased Companies Act 2006 thresholds will also apply retrospectively to any financial years beginning before 6 April 2008 in determining whether a company qualified as small in the previous years. It needs to be stressed that the 2006 thresholds will only be applicable in retrospective in the context of determining the status of a company for years beginning after 6 April 2008, i.e. to ascertain the small entity status of a company for years beginning before that date the 1985 Act thresholds will still apply.

Examples in respect of the application of the two-year rule and of the 2006 Act thresholds  

Section 384 of the Act indicates the companies that are excluded from the small companies' regime. The exclusions mirror those contained in the 1985 Act and affect among the others public companies and members of ineligible groups.

The conditions for exemption from audit for a company that is not part of a group are included in section 477 of the 2006 Act.

To be exempted from audit in respect a financial year beginning on or after 6 April 2008 a company needs to meet all of the following conditions:

• that the company qualifies as a small in relation to that year
• that its turnover in that year is not more than £6.5m
• that its balance sheet total for that year is not more than £3.26m.

A company will therefore need to qualify as a small company in accordance to the criteria stated in the paragraph above before it can test its turnover and balance sheet conditions to obtain audit exemption. It is important to state that if the company fails even only one of the conditions it will not be able to be exempted from audit. Furthermore there is no equivalent of the two-year rule as far as audit exemption is concerned and the relevant conditions need to be fulfilled in the specific year for which exemption is to be claimed, whilst the fact that the conditions had been met or failed in prior years has no relevance.

Section 478 of the Act indicates which companies are excluded from the possibility of obtaining audit exemption. The exclusions mirror those contained in the 1985 Act and includes public companies.

Qualification as small and audit exemption for group companies

Companies can be part of a group by virtue of being a parent, a subsidiary or both at the same time.

A company that is part of a group only by virtue of being a subsidiary will qualify as small by meeting the same conditions applicable to a non-group company, as contained in section 382 of Act, that have been discussed above. The exclusions from the small companies' regime outlined in section 384 of the Act will equally apply to such a company and particular care should be taken to verify whether the company is a member of an ineligible group.

A company that is the parent of a group or a parent and subsidiary in a group needs to meet the qualifying conditions set in section 383 of the Act to qualify as small in addition to the general conditions prescribed by section 382 and explained above.

Section 383 requires that a parent company qualifies as small in respect of a financial year only if the group headed by it qualifies as a small group.
A group would qualify as small in its first financial year if it meets at least two out of the three conditions outlined below:

• aggregate turnover not more than £6.5m net or £7.8m gross
• aggregate balance sheet total not more than £3.26m net or £3.9m gross
• aggregate number of employees not more than 50.

In respect of subsequent years the group will only incur a change in its status, e.g. from medium to small or from small to medium, if it respectively meets or fails two out of the three above conditions for both the current and the preceding financial year.

The two-year rule is therefore applicable to groups as well as companies in determining the qualification as small or medium. 

In relation to the aggregate turnover and balance sheet total, net would mean figures after any set-offs and other adjustments made to eliminate group transactions, while gross means without such set-offs and adjustments. It is important to notice that a group could satisfy any relevant requirement on the basis of either the net or the gross figure; therefore a mix of gross and net figures, i.e. net group turnover and gross balance sheet total, can be used to meet the qualifying conditions.

In a similar manner as for companies the Companies Act 2006 thresholds can be applied retrospectively to establish the size of the group for any previous years when that is instrumental in determining the size of the group for financial years beginning on or after 6 April 2008.

The exclusions of section 384 will also apply to a parent company and such company and all of its subsidiaries could be excluded from the small companies' regime if the group was an ineligible group.

The availability of audit exemption to a company that is part of a group, i.e. either a parent or a subsidiary, is regulated by section 479 of the 2006 Act. A company, which was at any time of the financial year a group company, would not be entitled to audit exemption in respect of that year unless all the following conditions are met:

• that the group qualifies as a small group in relation to that year and it was not at any time in that year an ineligible group
• that the group's aggregate turnover in that year is not more than £6.5m net or £7.8m gross
• that the group's aggregate balance sheet total for that year is not more than £3.26m net or £3.9m gross.

Any group company would therefore need to ascertain if the group of which it is part qualifies as a small before it can claim audit exemption. Both the group's aggregate turnover and balance sheet total figures would then need to be tested and need to meet the size conditions to avail from the exemption. It has to be noted that any relevant requirements can be met on the basis of either the gross or the net figure and therefore a mix of gross and net figures can be used to satisfy the criteria.

A group company can also be exempted from audit if throughout the whole of the period in which it was part of a group it was both a subsidiary and dormant.

[01/07/08]

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