Should ACRA Raise the Audit Threshold?

ACRA is reviewing the audit exemption criteria for Singapore companies. Should the audit thresholds be raised? Should certain subsidiaries be exempted from audit?

These questions often trigger strong reactions from the accounting profession. Some view it as deregulation. Others see it as necessary relief for small businesses.

But before debating numbers such as revenue thresholds or asset size, it may be more useful to step back and ask a more fundamental question.

Why do audits exist in the first place?

Once we understand the answer to that question, the policy discussion becomes much clearer.

The real purpose of financial reporting

To understand the purpose of audit, we must first understand the purpose of financial reporting.

Financial statements are prepared for shareholders.

Under Singapore's Companies Act, directors prepare the financial statements and present them to shareholders at the annual general meeting. The audit report is addressed to the members of the company.

This legal structure reflects a deeper economic reality.

In most companies, the people running the business are not the same people who own it. Managers control the firm's resources. Shareholders provide the capital.

Because of this separation, shareholders must rely on financial information to evaluate how their capital is being used.

Financial reporting therefore exists to bridge this gap.

Accounting theory describes this problem as information asymmetry. Managers naturally possess more information about the company than outside investors. Without credible reporting, investors cannot properly evaluate the firm.

Financial statements help convert internal information into publicly available information so that investors can make better decisions.

Audit then plays a supporting role. It enhances the credibility of the financial statements so that shareholders can trust the information provided.

The two information problems in companies

Accounting theory typically identifies two types of information asymmetry (Scott, W.R., Financial Accounting Theory, 5th ed., Pearson, 2009).

Adverse selection

Adverse selection arises when insiders know more about the company than outside investors.

Managers understand the firm's current condition and future prospects better than shareholders. Without credible disclosure, they could selectively release information or bias their reporting.

Financial reporting helps address this by providing structured disclosure. Audit adds another layer of credibility to that disclosure.

Moral hazard

Shareholders cannot observe how much effort managers actually devote to running the business. Managers might pursue their own interests instead of those of the owners.

Accounting information — particularly measures such as net income — helps evaluate managerial performance.

But for those numbers to be useful in contracts and compensation arrangements, they must be credible. Auditing provides assurance that the financial statements follow recognised accounting standards and are not manipulated by management.

This is why audit exists. Not because the law requires it, but because investors require credible information.

When does audit add real value?

Once we frame audit in terms of information asymmetry, its value becomes clearer.

Audit is most valuable when there is a genuine separation between ownership and control:

• Listed companies
• Companies with multiple shareholders
• Businesses funded by external investors
• Firms with significant debt financing

In these situations, shareholders and creditors cannot directly observe the company's activities. They rely on financial reporting. Audit strengthens the credibility of that reporting.

This is why audit is central to capital markets. Without trustworthy financial information, investors would demand higher returns or avoid investing altogether.

When does audit become compliance?

Not all companies have this separation between owners and managers.

Consider a typical small private company in Singapore. Often:

• The shareholders are also the directors
• The directors run the daily operations
• The owners have full access to the company's records

In such cases, the information asymmetry problem largely disappears. The shareholders already know what is happening inside the business because they are the ones running it.

When audit is imposed in these circumstances, it often becomes compliance rather than assurance.

The audit may still produce a technically correct report. But the underlying economic purpose of audit — reducing information asymmetry between owners and managers — is largely absent.

Audit is not inherently valuable. Its value depends on the information environment of the company.

The current audit exemption framework

Singapore already recognises this reality.

Under the Companies Act, section 205B, a company qualifies as a small company and is exempt from statutory audit if it satisfies at least two of the following criteria for the immediate past two financial years:

• Revenue not exceeding S$10 million
• Total assets not exceeding S$10 million
• Number of employees not exceeding 50

For groups, every entity within the group must independently qualify.

ACRA's current consultation is exploring whether these thresholds should be raised and whether certain subsidiaries should be exempted from the group test. These discussions are not unique to Singapore. Many jurisdictions periodically revisit audit thresholds as business environments evolve.

However, the deeper question remains: should audit exemption be determined by size at all?

The limitations of size thresholds

Revenue, assets, and employee count are easy to measure. That makes them convenient regulatory thresholds.

But they are blunt instruments.

A company with S$12 million in revenue but a single owner-manager may have very little information asymmetry. Meanwhile, a company with S$5 million in revenue but ten passive shareholders may face significant information asymmetry.

The need for audit is therefore not primarily a function of size. It is a function of information relationships between stakeholders.

When regulation relies purely on size thresholds, it risks mandating audits where they provide little value while exempting cases where assurance might actually be useful.

A different approach: let shareholders decide

Instead of relying solely on size thresholds, an alternative principle could be considered.

Let shareholders decide whether an audit is necessary.

At each annual general meeting, shareholders could vote on whether to appoint an auditor for the upcoming financial year. This approach aligns the decision with those who benefit from the assurance.

If shareholders value the credibility provided by an audit, they will appoint one. If they do not see the need — for example when shareholders and directors are the same individuals — they may decide to forgo it.

Such a mechanism reflects how many corporate governance decisions already work. Shareholders vote on directors. They vote on dividends. They approve major transactions. Allowing them to decide on audit would not be conceptually unusual.

Market discipline already works

In practice, many stakeholders already require audits regardless of statutory thresholds:

• Banks often require audited financial statements as part of loan agreements
• Investors typically demand audited accounts before committing capital
• Joint venture partners may require audit for governance purposes

In these situations, audit arises naturally through commercial negotiation, not legal obligation. Where assurance has economic value, stakeholders will demand it.

Where should safeguards remain?

A purely shareholder-driven model cannot apply to all companies. Certain entities involve broader public interest:

• Listed companies
• Financial institutions
• Entities holding client funds
• Businesses operating in regulated sectors

In these cases, statutory audit requirements remain essential. The broader public and the financial system rely on credible financial information from these organisations.

What does this mean for the accounting profession?

Whenever audit thresholds are discussed, the accounting profession often worries about declining audit demand. These concerns are understandable.

However, the long-term strength of the profession does not depend on mandatory compliance work. It depends on trust and value.

When audits are performed purely because the law requires them, they are often seen as a cost. When audits are performed because stakeholders genuinely value assurance, they are seen as a service.

The profession may ultimately benefit from focusing on engagements where assurance truly matters.

The future of assurance

The nature of audit itself is also evolving.

Technology is transforming how financial data is generated, processed, and analysed. As accounting systems become more automated, the role of auditors is shifting towards validating systems, rules, and data integrity rather than manually testing transactions.

Future assurance may focus less on periodic sampling and more on continuous monitoring of financial systems.

In such an environment, the debate about audit thresholds may gradually become less important than the broader question of how assurance should evolve in a digital economy.

The real question

ACRA's consultation raises an important policy discussion.

But the debate should not stop at whether the revenue threshold should be S$10 million or S$20 million.

The deeper issue is about who should decide whether assurance is necessary.

If financial statements exist primarily for shareholders, then shareholders should have a central role in deciding whether they require audited financial statements.

Size thresholds may still play a role as a practical safeguard. But they should not be the only principle guiding the discussion.

Because ultimately, the purpose of audit is not regulation. It is trust. And trust is most valuable where information asymmetry truly exists.