Johnathan Dudley, National head of SME Corporate Business, said that some businesses were in danger of having their credit ratings significantly downgraded if they failed to act now. This could push some firms into insolvency, with potential business failures and consequent job losses.

He said that two separate issues were set to have a potential impact on thousands of SMEs.

A revision to Financial Reporting Standard 102 (FRS102) from 1st January 2026, has significant implications from as early as this New Year’s Eve, just weeks away.

In future, leases of plant, equipment and, critically, premises currently treated on an annual cost basis as “operating leases”, will need to be treated as capitalised at the present value of future rentals.

Mr Dudley explained: “So, for example, a company with a £200,000 per annum rent bill on a ten-year lease will have its ‘total assets’ increased by up to £2 million, at the ‘stroke of a pen’ and cause some companies to require an audit as a result.

“And that means that past financial results need auditing too, to avoid a qualification of an audit report. The overall effect goes back three years, in practice,” he added.

The effect of this is that to avoid a qualification of, at least, comparative amounts, companies affected, may need to act as early as 31st December 2024, where stock is material, at least.

Mr Dudley said: “Auditors cannot attend a stock count, retrospectively, two years hence.”

He explained that the Department of Business and Trade had also proposed a 150% uplift in the financial thresholds for businesses requiring statutory audit back in March 2024.

“While seeming to be a generous increase, this would have been little more than inflation and in any case, ignores the effect of FRS102 leasing changes.

“The threshold increases proposed in March to take effect from October were not adopted by the government due, presumably, to the general election being called. The King’s Speech mentioned audit reform, believed to be scheduled for 2015; but clarity is needed as to whether the proposed increases will be adopted or whether something else is envisaged?

“Put the two points together and there is currently uncertainty as to whether companies might be affected.

“In the meantime, with the very real prospects for SMEs to fall foul of existing audit, asset value thresholds for the first time, by applying the new regulations required on leases, applicable under the revised FRS102, with action required from the end of this calendar year, some urgent action is needed.

“Sadly, these days, even a technical audit qualification is regarded as grounds to downgrade credit rating by the agencies, and this can prove catastrophic for businesses.”

Background

Currently, the requirement to have a statutory audit occurs when a business meets two out of three of – average employee numbers of 50 or less, sales of £10.2 million or less and total assets (not including liabilities) of £5.1 million or less.

Mr Dudley explained: “A company with, for example, 60 employees and £8 million of sales and £5 million of total assets on 31st December 2025, could easily fail the audit requirement test, the following day.”

Although, the rules allow for a “one year grace period”, the need to audit ‘comparative numbers’ still requires action from now and anyway, this is intended to deal with temporary spikes in the thresholds, so unless there are drastic changes planned, action will be advised to at least prepare for the inevitable, as early as possible.

Mr Dudley said: “Of course, since March, there has been a general election, we have a new government, and the King’s Speech included mention of audit reform, but it remains to be seen whether the following legislation includes any audit threshold changes. At present, therefore, we still have the 2016 numbers unchanged, as above.”

The impact of needing to do an audit for the first time, or after a break, is significant and potentially expensive.

If an audit is required, then to issue a “clean” report, the auditor not only has to express an opinion on current year end, but also the opening balances at the start of the year, which were not previously audited and the comparative amounts for the last financial year too, also the opening balances for that year as well.

Much more than a single year’s audit with commensurate significant cost.

Mr Dudley explained: “If any of the above is not possible, or if the company decides to not have prior results retrospectively audited, then a qualification will be necessary. While this might be limited, unfortunately, credit referencing agencies do not distinguish for what they consider to be a binary issue.

“An audit is either ‘clean’ or ‘qualified’. And if its qualified, then they commonly, downrate or remove credit limits accordingly.

“In addition, there is also the effect of recognising the associated leasing liability to consider. Could this breach banking covenants, and make the risk associated with a possible credit referencing adjustment, even worse?

“Depending on the funding of a business, this could cause catastrophic cash flow issues and even business failure.”

He is urging businesses who may be affected to contact their professional advisers immediately to mitigate the risk of a potential downgrading of their credit rating.

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