Journal of Accounting Perspectives, Vol 5, December 2012, 1-22 ISSN 1985-7136

AUDIT EXEMPTION FOR MALAYSIAN

SMEs: DOES OWNERSHIP MATTER?

Engku Ahmad Khairuddin Engku Mohd Anuar, S. Susela Devi1 and

Chan Wai Meng

Abstract

Small and medium-sized enterprises (SMEs) are playing an increasingly

important role in the process of industrialization in the developing world.
To support SMEs, many developed countries, such as Australia, New
Zealand and the United Kingdom, have implemented an audit exemption
regime for SMEs, while, in Malaysia, the policy makers and regulators
have announced that the audit for SMEs will remain a legal obligation that
they will revisit sometime in the future. Thus, this paper aims to shed light
on this issue by exploring the relationship between the ownership structure
of SMEs and audit exemption. The objective is to determine whether
SMEs will still opt for an audit if it becomes voluntary, and, if they do,
what would be the reason for the sampled SMEs to behave in such a
manner? This research is exploratory in nature and employs the
questionnaire survey method to collect data from a random sample of 200
SMEs in both the manufacturing and service industries. The survey results
indicate that there is a significant difference between the ownership structure
of firms and the decision of SMEs to opt for voluntary audit. Moreover,
the lack of resources is significantly related to opting for a voluntary audit.
Therefore, based on the resource-based theory, SMEs in Malaysia mainly
opt for auditing, not to fulfil a mandatory obligation but to compensate for
their lack of tangible (professional/qualified accountants) and/or intangible
(accounting and business expertise) resources. This study provides new
insights into the way Malaysian SMEs view auditing. It highlights the
implications of the policy directives of the Malaysian regulators and the
accounting fraternity. Furthermore, the Malaysian experience is useful for
consideration by other developing nations that are contemplating moving
towards an audit exemption regime.

Keywords Auditing, SMEs, Agency theory, Resource dependency theory,

Resource-based view, Malaysia
1
Corresponding author: Dr Susela Devi is a Professor at the Faculty of Business and Accountancy,
University of Malaya, email: susela@um.edu.my. Dr Chan Wai Meng is a Senior Lecturer at the
Faculty of Business and Accountancy, University of Malaya.

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 Engku Ahmad Khairuddin Engku Mohd Anuar, S. Susela Devi and Chan Wai Meng

1. Introduction
In this globalised era, many developed countries, such as the United States,
the United Kingdom, Australia, New Zealand and Singapore, have already
implemented a regime of audit exemption for small and medium-sized enterprises
(SMEs). In the United States, there is no statutory audit requirement except
for listed companies in compliance with the requirements by the Securities
and Exchange Commission (SEC). However, in many of the Commonwealth
countries (e.g. Pakistan, India and Malaysia), audits are mandated for all registered
companies (with some exceptions for exempt private companies and dormant
entities). Increasingly, there is a growing realization that smaller businesses need
not be subject to the stringent audit requirement imposed on larger businesses
with public accountability. In 2003, Singapore took steps to exempt the audit of
smaller businesses. Many countries, such as India, Pakistan, Hong Kong and
Malaysia, are still debating the issue of audit exemption for SMEs.
Overall, the benefits of auditing have been widely supported by the agency
theory (Wallace, 1980; Ng, 1978; Jensen and Meckling, 1976). However, as
the literature on the association between the separation of ownership, control,
and the demand for auditing is quite inconclusive, there is a demand for more
empirical research to be conducted (Seouw, 2001; Senkow et al., 2001; Carey
et al., 2000; Barfield et al., 1993; Chow, 1982). In view of the fact that SMEs
generally exhibit lower levels of agency conflict (Carey et al., 2001), there are a
number of reasons they may opt for an audit. The primary explanation of demand
for auditing is that it serves as a monitoring role, which enhances the credibility
of financial information (Carey, 2010). Traditionally, auditors provide advice to
management, either by raising issues pertaining to internal control discovered
through the process of an audit (Arens and Loebbecke, 1976), or by assisting
the owner-managers of SMEs to control their business (Abdel-Khalik, 1993).
Moreover, since external accountants have progressively developed a broader
business perspective (Fogarty et al., 2006; Greenwood et al., 2002), they are
able to provide their clients with business advice from a fresh perspective and
improve their performance level. This is also encouraged by the fact that there are
no legislative restrictions in the SME environment on auditor-provided business
advisory services either as a separate service or as part of the external audit.
In addition to the agency theory, this study draws on another two
management theories – resource dependency theory and resource-based view –
that are applicable to auditing, the benefits of which are mentioned above. First,
based on the ‘resource dependency theory’, limitations on the availability of
resources foster specialization and necessitate organizational interdependence,
thereby creating resource dependencies (Ulrich and Barney, 1984; Cook and
Emerson, 1984; Pfeffer, 1981; Pfeffer and Salancik, 1978; Cook, 1977). In view of
the beneficial role played by auditing firms in providing specific services to SMEs,
the limitations on the part of SMEs have been revealed. It can be recognized that
Malaysian SMEs might fall short of the standard accounting qualities concerning

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 Audit Exemption for Malaysian SMEs: Does Ownership Matter?

expert knowledge or business consultancy, which are intangible resources already

available in auditing firms.
Secondly, the resource-based view of the firm conceptualizes the enterprise
as a “bundle of unique resources” (Penrose, 1959). Therefore, the growth of the
firm is both facilitated and limited by management’s search for the best usage
of available resources (Penrose, 1959). These include tangible and intangible,
human and non-human resources that are possessed or controlled by the firm
and that permit it to devise and apply value-enhancing strategies (Barney, 1991;
Wernerfelt, 1984). The resource-based view sees resources as inherently valuable,
and holds that the firm’s unique resources should define the essence of strategy
(Spanos and Lioukas, 2001; Kamyabi and Devi, 2011). Taking this perspective
also entails that “the dynamic capabilities” of a firm are “an aid to management
endeavoring to gain competitive advantage” (Teece et al., 1997). Dynamic
capabilities equip the firm with the “ability to integrate, build, and reconfigure
internal and external competencies to address rapidly changing environments”
thus achieving competitive advantage (Teece et al., 1997).
Therefore, based on the theoretical background, we can infer that,
theoretically, there would be a relationship between these three theories and the
willingness to opt for voluntary audit when exemption is offered. Surprisingly,
this has hardly been the case in the field of accounting, more specifically in the
context of Malaysia, the resource-based view and resource dependency theory,
and their interface are being adopted to examine the relationship between SMEs
having sufficient accounting resources and the capabilities to deploy them in
relation to audit issues. Accounting resources here refer to professional accounting
know-how, expertise, human resource, and budget
The originality of this study comes from its ability to fill this gap by
addressing the intriguing question of whether Malaysian SMEs will opt
for a voluntary audit when exemption would be an option; this has been an issue
in Malaysia since the early 1990s (Abdul Aziz, 2002). Thus, it can be
hypothesized that their lack of accounting resources necessitates organizational
interdependence, which, in turn, creates resource dependency. This resource
dependency is the influencing factor that leads to a ‘voluntary audit’ when given
the option of whether or not to audit. Now, as the regulators and policy makers
are bewildered concerning whether to making the audit for SMEs a voluntary
task or a mandatory requirement, the results of this study provide enlightenment.

2. Research Background
2.1 Corporate Governance and Audit Requirement
The theory that has been widely quoted in the literature to explain the function
of audit is the ‘agency theory’ as propounded by Jensen and Meckling (1976).
In a firm, the management is separated from its ownership. The management is
in the hands of the board of directors, who are appointed by the shareholders at

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 Engku Ahmad Khairuddin Engku Mohd Anuar, S. Susela Devi and Chan Wai Meng

their annual general meeting. As the directors’ interests may not be aligned with
those of the shareholders, the audit function serves to provide credibility to the
financial statements presented by the directors to the shareholders.
The board, or any of the directors, may be removed by the shareholders
at a general meeting, as the directors, being the agents, are answerable to their
principals, i.e. the shareholders. Thus, there are provisions in the company
legislation requiring a company to call for a general meeting at least once a
calendar year. At the meeting with the shareholders, the board of directors is
supposed to give an account of the company’s affairs to the shareholders, which
include the company’s financial information.
The financial statements form the basis for evaluation by shareholders of
the company’s financial position and performance. However, this method may
not be fool proof, as the directors have control over the manner of presenting
the financial information and its contents (Sikka, 2009). The risk of dishonesty
on the part of the directors is real, thus giving rise to the agency theory (Jensen
and Meckling, 1976). The information asymmetry between the directors and the
shareholders and the moral hazard risk are factors motivating the shareholders to
willingly incur costs to monitor the activities of their agents, i.e. the directors of
the firm. One way is to have an independent third party to review the financial
information, a device welcomed by both parties. To the principal, the financial
statements provided by the agent have been attested by an independent auditor,
and, to the agent, the audit confirms the quality of information provided to his
principal (Tabone and Baldacchino, 2003).
The agency theory might have caused the enactment of the first mandatory
audit provision in English in 1879, as an aftermath of a financial scandal. Section
7 of the Companies Act 1879 was enacted to restore the public’s confidence in the
banking industry after the collapse of the City of Glasgow Bank, which falsified
its accounts to ensure that it remained an investor’s favourite.
The agency theory is more relevant and applicable in a complex set-up in
which the directors have only a minor stake in the firm, and, thus, may work
towards maximizing their personal gains instead of the shareholders as a body.
Despite that, the audit requirement was subsequently extended to all firms
through section 21 of the English Companies Act 1900. This was to ensure that
the shareholders received reliable and accurate information that reflects the
company’s financial position, as the financial information has to be examined by
a third party, i.e. an auditor. The audit requirement was adopted by the legislatures
in most, if not all, Commonwealth countries, and Malaysia was no exception.
A century after the introduction of the mandatory audit in the UK, steps were
taken to reverse the requirement for selected companies with effect from 1981.
Under section 12 of the UK Companies Act 1981, a dormant company is exempted
from this requirement. Additional costs, as a result of the implementation of a
directive on auditors’ qualifications, further liberalized the statutory requirement.
In 1994, the UK Companies Act 1985 (Audit Exemption) Regulations 1994 were

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 Audit Exemption for Malaysian SMEs: Does Ownership Matter?

passed to exempt small companies from annual audits despite opposition from the
Inland Revenue and bankers. Through the years, the tests for a “small company”,
which were based on the size of its balance sheet, turnover and workforce, went
through many changes. In 1994, the maximum turnover for a small company
was ₤90,000; this was gradually increased to ₤300,000 and ₤1 million in 1997
and 2000, respectively, and raised to ₤5.6 million under section 477 of the UK
Companies Act 2006.
It should be stressed that the legislature recognizes the relevance of the
agency theory, for such exemption is subject to the overriding rights of the
shareholders to demand an audit. Section 476 of the UK Companies Act 2006
provides that shareholders holding at least 10% of the company’s issued capital
may require the company to have its accounts audited. Thus, it is to be expected
that where the directors have a minor stake in the company, the shareholders
would require the accounts to be audited. This is supported by Tauringana and
Clarke (2000), and Collis et al. (2004).

2.2 Evolution of Businesses and Impact of Globalization

Much focus has been directed on fine-tuning the audit practice. The International
Federation of Accountants (IFAC) has been issuing guidance on auditing since
1979.2 Initially, these were known as International Auditing Guidelines. However,
subsequent to the many notable corporate debacles (for example, Enron and
WorldCom), the authority of these guidelines was enhanced, and, subsequently,
renamed the International Standards on Auditing (ISAs). The Standards apply
to audits conducted on big and small businesses. The rationale being that “one
size fits all”.
Many member bodies of IFAC and their respective members, especially
small medium practitioners (“SMPs”) and members of the profession from
developing nations, struggle to cope with the complexities and volume of
international standards (IFAC 2004). This has brought forth the issue concerning
the relevance of audits for small businesses.
The issue of ‘relevance’ arises from the fact that the International Standards
on Audit (ISAs) were chiefly written for public listed companies, and, thus, have
eroded the relevance of ISAs to SME audits. The complexity and large entity
bias of ISAs makes them difficult, and, hence, costly to apply to SME audits
(IFAC, 2006).
Clearly, the issue of SME audit is becoming increasingly problematic. The
need for audit arises from the need to address the agency problem, as it provides
credibility to the financial statements of companies so that external users can
rely on these for economic decision-making. With the evolution of businesses,
companies have grown and diversified with many seeking cross border listings,
2
The International Auditing Practices Committee (IAPC) issued its first International Auditing
Guideline, Objective and scope of the Audit of Financial Statements in 1979. Since 2002, however, IAPC
was reconstituted as the International Auditing and Assurance Standards Board (IAASB).

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 Engku Ahmad Khairuddin Engku Mohd Anuar, S. Susela Devi and Chan Wai Meng

and, thus, extending their accountability to the public at large around the world.
To these companies, ISAs are very relevant and applicable as they are universally
applicable and recognized.
However, there are companies that operate with a family ownership structure
with very few external dependent users of the financial statements. In some
jurisdictions, including Malaysia, these companies are subject to mandatory
audits. Therefore, the issue is whether this is necessary considering their capacity.
The trend seems to be shifting towards deregulating the audit requirement for
the smaller companies.

2.3 Development in other Countries

Australia deregulated its audit requirement as early as 1971 when the Australian
Uniform Companies Act 1961 was amended to exempt a small private company
from compulsory audit provided that all its shareholders consent thereto. The
Companies Act has since been repealed, and, now, under the Corporations Act
2001, a small company is even excused from having to prepare a financial
report, and, thus, is exempted from having to appoint an auditor unless, first, it
is controlled by a foreign company that has not lodged its consolidated account
with the Australian Securities and Investments Commission (ASIC); second, its
shareholders, who are holding at least 5 per cent of its voting shares, require it; and,
third, the ASIC requires it (section 292 of the Australian Corporations Act 2001).
In Singapore, in 2000, the Institute of Certified Public Accountants of Singapore
(ICPAS) conducted a survey concerning the issue of audit exemption. The findings
indicated that audit exemption was undesirable (ICPAS, 2000). However, despite
the findings of the survey, the legislature amended its Companies Act in 2003 to
exempt dormant and private companies from audit requirements. The threshold
was set at S$2.5 million, and was subsequently increased to S$5 million in May
2004. As in Australia, shareholders holding at least 5 per cent of the company’s
issued shares, or the regulator, may require the company’s accounts to be audited
(section 205B, 205C and 205D of the Singapore’s Companies Act).

2.4 Development in Malaysia

Malaysia has embarked on a review of the company law. The Company Law
Reform Committee was established on 17 December 2003 to reform the company
legislation to make it current and in line with the best practices elsewhere (SSM,
2008). One of the steps taken by the Committee was to commission a survey to
obtain the views of directors of SMEs on audit exemption. Most of the respondents
indicated that they were willing to carry out audits even if the requirement for
mandatory audits was removed from the Companies Act 1965. Nevertheless, the
Committee, in its Final Report in 2009, recommended the retention of mandatory
audit for all companies; however, powers should be given to the regulator to
exempt certain types of companies from this requirement. The criteria suggested
are based on the number of the company’s shareholders, annual turnover, and

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 Audit Exemption for Malaysian SMEs: Does Ownership Matter?

number of employees (SSM, 2009). Thus, the possibility of the mandatory audit
regime for small companies being overturned cannot be ruled out. What then is
the impact of this on the audit firms?
In Malaysia, due to the limited resources of small private limited companies,
those that are not subsidiaries of public listed companies tend to be audited
by smaller audit firms, i.e. the SMPs. A survey carried out by the Malaysian
Institute of Accountants revealed that out of the total of 1,551 SMPs registered
with the Institute as at 29 May 2003, more than 92 per cent were sole proprietors
or 2 partner firms. Approximately 66 per cent of the revenue of such firms was
dependent on audit service (MIA, 2003). Thus, the issue of audit exemption is
especially of interest to the SMPs, because, for them, an exemption regime would
mean a reduction in their audit revenue.

2.5 Past Studies on Audit of Small Firms

The need to understand the implications of introducing an audit exemption regime
was recognized as early as 1982. Studies have been conducted on the demand for
an external audit and the characteristics of companies that favour an external audit.
Chow (1982) examined the data of 165 New York Stock Exchange (“NYSE”) and
over-the-counter (“OTC”) companies for the year 1926. In that year, there was no
externally imposed audit requirement. Chow found only moderate support for the
hypothesis that the larger the company’s total size, the higher the probability that
the company voluntarily engages in external auditing. Due to the lack of data, the
correlation between manager ownership and voluntary audit was not examined.
However, in subsequent studies in other jurisdictions, the correlation between
the demand for voluntary audit and manager ownership was examined. Senkow
et al. (2001) surveyed 896 Canadian companies that were given the opportunity
to discontinue audit and found that the correlation of the two variables was not
significant. However, studies conducted by Carey et al. (2000) on Australian
family businesses, and by Tabone and Baldacchino (2003) on owner-manager
companies in Malta found that the demand for voluntary audit is positively
correlated with the proportion of non-family management. The earlier surveys
(Collis et al., 2004; Seouw, 2001; Tauringana and Clarke, 2000) showed
consistency with the theory that the demand for auditing is correlated to a greater
loss of control by the owners, which leads to a demand for monitoring.
Another characteristic of a company that will opt for audit if it is given an
option is that its directors have knowledge of the benefits of audit (Collis et al.,
2004). Thus, it follows that companies that find audit to be beneficial are more
likely to retain audit after its deregulation (Senkow et al., 2001; Collis, 2008).
Audit acts as a check on internal controls (Collis et al., 2004), on accounting
systems and controls (Collis, 2008); and it increases the quality of information
(Collis et al., 2004; Tabone and Baldacchino, 2003). In addition, Tabone and
Baldacchino (2003) found that the external audit imposes discipline on the owner-
manager and staff to avoid errors and other irregularities.

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 Engku Ahmad Khairuddin Engku Mohd Anuar, S. Susela Devi and Chan Wai Meng

Surprisingly, Seouw (2001) found that factors, such as the strength and
quality of the working relationship between the company and its auditors, do
not play a significant role in the company’s decision concerning whether to opt
for voluntary audit. Instead, there is evidence that the company may consider
the cost factor when deciding whether to go for audit if given the choice. Costs
include monetary and management time spent in carrying out the audit.
In Malaysia, Salleh et al. (2008) surveyed the opinions of the SMPs’
concerning the audit of small companies and the proportion of its contribution
to their revenue. Approximately 76.6 per cent of the SMPs are of the view that
all companies, irrespective of size, should be subject to mandatory annual audits.
As expected, the majority of these SMPs are small firms (68.8 per cent) that
rely heavily on audit as the major contribution to their income (59.4 per cent).
Their fear of losing this source of income may be the reason for polling against
the deregulation of audit for small businesses. This is the only previous study
conducted in Malaysia that examines the issue of voluntary audit (Chan, 2012).
According to the survey commissioned by the Corporate Law Reform
Committee on the directors of private limited companies, 71 per cent of the
respondents say that they will carry out audits even if the requirement for
mandatory audits is removed from the Companies Act 1965. Approximately
82 per cent of them found audit to be beneficial as it provides assurance to its
creditors, and improves its record keeping and internal control (CLRC, 2007).
Unfortunately, the study, which was conducted in early 2005, the results of which
were released in February 2006, did not analyse the ownership characteristics
of such companies.
Thus, this study was conducted after the commencement of the above-
mentioned survey commissioned by the Corporate Law Reform Committee,
to determine whether there is a significant difference between the ownership
structure of SMEs and their opting for voluntary audit when it is no longer a matter
of obligation. The results will be beneficial to both practitioners and regulators
by assisting them in taking the correct path either towards making SME audit
voluntary or retaining it as a legal obligation.

2.6 Theoretical Model

Based on the above review of the literature, two main variables have been
identified that are hypothesized to be critical in opting for voluntary audit. Figure
1 shows the theoretical model developed as a starting point for the exploratory
phase of the research.
This model links the ownership structure of SMEs and their resources for
making the choice for a voluntary audit, which are explained as follows:
Ownership structure has been discussed as an independent variable in
relation to SME audit in several studies (see Collis, 2008; Collis et al., 2004;
Collis, 2003). Furthermore, Anderson et al. (2003) looked into the founding
family ownership in respect of its lenders. In addition, the correlation between the

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 Audit Exemption for Malaysian SMEs: Does Ownership Matter?

SMEs’ Ownership Structure

Opting for Voluntary Audit

SMEs’ Resources

Figure 1: Influencing Factors on SMEs’ Voluntary Audit

demand for voluntary audit and manager ownership was examined. In Canada,
Senkow et al. (2001) did not find a significant relationship between managerial
ownership and voluntary audit. However, Carey et al. (2000), in their study on
Australian family businesses, found a positive association between the proportion
of non-family management and demand for voluntary audit. Similarly, Tabone
and Baldacchino (2003) found that for owner-managed companies in Malta, the
demand for voluntary audit was positively correlated with the proportion of non-
family management. Hence, there is support in the literature (Collis et al.,
2004; Seouw, 2001; Tauringana and Clarke, 2000) that the demand for auditing
is correlated to a greater loss of control by the owners, which, thus, leads to
demand for audit.
In this study, we classify the ownership structure into three categories;
namely, wholly family-owned (WF), partly family-owned (PF), and non-family
owned (NF). Non-family owned includes unrelated shareholders. This variable
is strongly rooted in the agency theory (Jensen and Meckling, 1976), which
asserts that the demand for audited financial statements arises from information
asymmetry on the premise that human nature is weak, untrustworthy and in need
of some kind of checking (Power, 1997).
Based on the above discussion, we hypothesise that:

H1: There are significant differences between the different modes of

ownership structure (wholly family-owned, partly family-owned, and
non-family owned) and SMEs opting for voluntary audit.

Interestingly, in a subsequent study by Collis (2008) on medium sized

companies in the UK that do not enjoy audit exemption, 73 per cent of the
responding firms that were closely held, indicated that they would continue to have
their accounts audited even if the exemption was extended to them. Given that,
generally, the agency rationale is applied to large firms, the evidence from Collis
(2008) suggests that there may be other factors that may lead to the willingness
of SMEs for audit. We identify SME resources as one of the factors.
SMEs’ resources include tangible and intangible, and human and
nonhuman resources that are possessed or controlled by the firm. Based on the

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 Engku Ahmad Khairuddin Engku Mohd Anuar, S. Susela Devi and Chan Wai Meng

‘resource dependency theory’, limitations on the availability of resources foster

specialization and necessitate organizational interdependence, thus, creating
resource dependencies (Ulrich and Barney 1984; Cook and Emerson 1984;
Pfeffer 1981; Pfeffer and Salancik 1978; Cook 1977). Therefore, as SMEs may
be crippled by the “capacity problem” or a lack of resources, such as qualified
accountants, business expertise, right mechanisms, as noted by IFAC (2006),
would seek for the obvious benefits derived from the audit process. In doing so,
they would be able to compensate for their lack of resources, and, therefore, the
benefits gained would outweigh the cost incurred via audit. Evidence from Iranian
SMEs shows that resource dependency is a significant factor to motivate SMEs
to outsource their accounting functions (Kamyabi and Devi, 2011). Therefore,
based on this resource-dependency rationale for audit, we can link the resources
of SMEs’ to opting for voluntary audit. We hypothesise that:

H2: Lack of SMEs’ resources is significantly related to opting for

voluntary audit.

3. Methodology
This study is exploratory and descriptive in nature. The data collection method
employed is a questionnaire survey targeting SMEs registered with the Small and
Medium Industries Development Corporation (SMIDC) in Malaysia. The full
directory list of SMEs registered with the SMIDEC was obtained online, and, as at
23 February 2005, the number of registered SMEs located in Selangor and Kuala
Lumpur, Federal Territory, totalled 4,838 companies, and formed the population
of this study (SMIDEC, 2005). Out of this population, 235 companies, which
represent both manufacturing and service sectors, were randomly selected. To
name a few, manufacturing companies, such as chemical petrochemical products
(71 companies); electrical and electronics including telecommunication (1,294
companies); machinery and engineering (769 companies); metal products (872
companies); transport equipment (658 companies); wood and wood products
(41 companies); food, beverages and tobacco (88 companies); and service
firms, such as professional management services (31 companies); retail and
wholesale distributive trade (10 companies ); logistics (2 companies); IT services
(1 company); and hospitality services (1 company), were available within the
population directory, and in the sampled population accordingly.
In 2005, the National SME Development Council (NSDC) approved the use
of common definitions for SMEs in the manufacturing, manufacturing-related
services, primary agriculture and services sectors.3 These definitions are applied by
all Government Ministries and Agencies involved in SME development, as well

3
Classification of economic activities is based on the Malaysian Standard Industrial
Classification (MSIC) 2000 codes.

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 Audit Exemption for Malaysian SMEs: Does Ownership Matter?

as by the financial institutions (SMEinfo, 2010). Malaysian SMEs are classified

into three main categories: micro, small or medium. These groupings are decided
based on either the number of people a business employs, or on the total sales
or revenue generated by a business in a year. According to Wignaraja (2003),
different criteria can be used to distinguish between an SME and a large firm
in a developing economy. Three possible criteria are the number of employees,
the value of sales and the value of production equipment. In this study, as the
determinants of firm classification, the number of full-time employees in all
national business sites as well as annual sales turnover, have been considered.
Tables 1 and 2 show the classification of the SMEs based on the number of full-
time employees and annual sales turnover.

Table 1: Number of Employees

Manufacturing
Primary Services Sector
(including
Agriculture (including ICT**)
Agro-Based) & MRS*
Less than 5 Less than 5
Micro Less than 5 employees
employees employees
Between 5 & 19 Between 5 & 50 Between 5 & 19
Small
employees employees employees
Between 20 & 50 Between 51 & 150 Between 20 & 50
Medium
employees employees employees
*MRS: Manufacturing-Related Services
** ICT: Information and Communications Technology
Source: SMEinfo, 2010

Table 2: Annual Sales Turnover

Manufacturing
Services Sector
(including Agro-
Primary Agriculture
(including ICT**)
Based) & MRS*
Micro Less than RM200,000 Less than RM250,000 Less than RM200,000
Between RM200,000 Between RM250,000 Between RM200,000
Small & less than RM1 & less than RM10 & less than RM1
million million million
Between RM10
Between RM1 million Between RM1 million
Medium million & RM25
& RM5 million & RM5 million
million
*MRS: Manufacturing-Related Services
** ICT: Information and Communications Technology
Source: SMEinfo, 2010

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 Engku Ahmad Khairuddin Engku Mohd Anuar, S. Susela Devi and Chan Wai Meng

Based on the above classification and with the assistance of the SME
directory, 235 questionnaires were sent through email, fax and by hand delivery
to the managing director or chief financial officer of the respective firms. It is
believed that these managers are better able to provide a more rational opinion
on the subject of audit as they would know how the introduction of voluntary
audit could impact them. The questionnaires were also accompanied by letters of
appreciation and instructions. The cover letter informed respondents of the aims
of the project and the main benefits of undertaking such a study. It also informed
participants about the issues of privacy relating to sensitive business information.
After two to three days, follow up telephone calls were made to encourage them
to respond. Finally, a total of 200 usable responses were obtained, representing
a response rate of 85 per cent.
The questionnaire used in this study is mainly based on a questionnaire
used by the Institute of Certified Public Accountants of Singapore (ICPAS) in
December 2000, as well as the study on Directors Views on Exemption from
Statutory Audit conducted by Collis in the UK in 2003. There are 30 questions
in the questionnaire. Questions 1 to 7 are designed to elicit the respondent’s
demographic and profile, and questions 30 and 31 concern the position of the
respondent in the company and his qualification. The questionnaire also includes
questions on the role of the external accountant (question 8) and the option to
be an exempt enterprise for the purpose of financial reporting (questions 9 to
11). Overall, the rest of the questionnaire concerns the cost of audit and views
on the introduction of audit exemption for small and medium sized-enterprises
in Malaysia.

4. Results and Discussion

To obtain descriptive statistics for categorical variables, frequencies and
percentages are employed. To test the hypotheses of this study, an independent-
samples t-test is used. In what follows, the results are presented.

4.1 Descriptive Analysis – Responding SMEs

An analysis of the ownership structure of SMEs shows that the majority of
SMEs have non-related shareholders or are non-family owned (82 out of 200 or
41 per cent); 66 SMEs are partly-family owned (33 per cent); and 52 are wholly
family-owned (26 per cent).
The analysis of the number of accountants in the SMEs who are employed
in a financial role reveals that 96 out of the 200 SMEs have only one accountant
(48 per cent); 8 SMEs have only two accountants (4 per cent) and 96 SMEs do
not have any employee as an accountant (48 per cent).
The analysis of the qualification level of the accountants employed by the
SMEs in descending order show that only 7 SMEs have ‘professionally qualified
accountants holding Certified Public Accountants (CPA)/Charted Accountants

12
 Audit Exemption for Malaysian SMEs: Does Ownership Matter?

(CA)/Association of Chartered Certified Accountants (ACCA)’ (6.3 per cent);

40 have ‘non-CPA degree holders registered with the Malaysian Institute of
Accountants MIA’4 (35.7 per cent); 43 have ‘semi-professional accountants
who have partially completed their professional examinations’ (38.4 per cent);
and 22 have ‘accounting technicians with London Chamber of Commercial
Industry (LCCI)/Association of Accounting Technician (AAT) qualification or
bookkeepers’ (19.6 per cent).
The analysis of the number of shareholders of SMEs show that the majority
of the responding SMEs have three to four shareholders (158 out of 200 or 79
per cent); 32 have five or more shareholders (15.6 per cent); and 10 SMEs have
one to two shareholders (5 per cent).
Lastly, the SMEs’ perceptions/views of the potential value of the audit were
measured on a five-point Likert-type scale by eight items that were designed
to elicit responses ranging from strongly agree to strongly disagree (allowing
multiple responses). The results, in descending order, show that, first, they mainly
use ‘audit’ as a check on accounting records and systems (198 out of 200, or 99
per cent, ticked strongly agree or agree); second, they acknowledge the value of
audit as it ‘helps protect against fraud’ (171 out of 200, or 85.5 per cent); third,
‘audit improves the credibility of the financial information’ (170 out of 200, or
85.0 per cent); fourth, ‘audit improves the quality of the financial information’
(169 out of 200, or 84.5 per cent); fifth, ‘audit provides assurance to shareholders’
(169 out of 200, or 84.5 per cent); sixth, ‘audit provides assurance to the bank and
other lenders’ (156 out of 200, or 78.0 per cent); seventh, ‘it has a positive effect
on company’s credit rating score’ (151 out of 200, or 75.5 per cent), and, finally,
‘it provides assurance to suppliers and trade creditors’ (151 out of 200, or 74.0
per cent). The views of the respondents on voluntary audit are important because
previous studies have shown that companies that find audit beneficial are more
likely to retain audit after its deregulation (Senkow et al., 2001; Collis, 2008).
Since this study is partly based on the previous studies, but in a new context, it
is more reliable to have at least a similar grounding concerning the perspective
of SMEs in relation to voluntary audit. However, the following results show that
some of the conclusions made in studies conducted in other contexts do not apply
to Malaysia.

4
Under the Accountants Act 1967 and subsequent amendments, holders of seven local universities’
accounting degrees and members of 11 professional bodies are eligible to directly become members of
the MIA. The bodies are: MACPA, Institute of Chartered Accountants in England & Wales, Institute of
Chartered Scotland, Institute of Chartered Accountants in Ireland, Institute of Chartered Accountants
in Australia, CPA Australia (successor to the Australian Society of Accountants), Chartered Institute of
Management Accountants, Association of Chartered Certified Accountants, Canadian Institute of Chartered
Accountants, New Zealand Institute of Chartered Accountants (successor to the New Zealand Society of
Accountants) and Institute of Chartered Accountants in India. Since 2001, members of foreign professional
bodies and graduates with degrees not recognized in the Act have been required to undergo the Qualifying
Examination. The inclusion of holders of local accounting graduates dates back to the 1970s. (See www.
mia.org.my)

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 Engku Ahmad Khairuddin Engku Mohd Anuar, S. Susela Devi and Chan Wai Meng

4.2 Testing Hypothesis 1: Ownership Structure

To examine if there is a significant difference between ownership structure and
SMEs’ opting for voluntary audit, the t-test was used. As noted earlier under
descriptive analysis, the majority of the respondents (41 per cent) have non-related
shareholders or are non-family owned. Partly family-owned SMEs constitute 33
per cent, and 26 per cent are wholly family-owned SMEs. Table 3 provides the
results of the analysis.

Table 3: Ownership Structure versus Voluntary Audit Decision

Strg Not Dis- Strg

P
Characteristic Agree Agree Sure agree Disag Mean t-test
value
5 4 3 2 1
Ownership 27.45 31.37 21.57 9.80 9.80 3.5686 3.2*** 0.0012 WF
Structure 17.19 31.25 31.25 9.38 10.94 3.3438 2.3** 0.0125 PF
10.84 13.25 48.19 20.48 7.23 3.0000 0.0000 0.5000 NF
17.17 23.74 35.86 14.14 9.09 3.2576 3.1*** 0.0011 All
Notes: 1)N = 198 (based on usable responses); 2) WF = Wholly Family-Owned, PF = Partly-Family
Owned, and NF = Non-Family Owned (unrelated shareholders); 3) *** significant at 0.001,
** significant at 0.05,

According to Table 3, based on the analysis of the mean scores of the

respective categories and the t-test conducted, it is noted that partly family-
owned SMEs favour voluntary audit at a .05 significance level, whereas wholly
family-owned SMEs strongly prefer voluntary audit at the .001 significance level.
Overall, both family-related ownership structures opt for voluntary audit, while, in
contrast, non-family owned SMEs seem to be not keen to opt for voluntary audit,
or are mainly undecided. This finding is in contrast to the results of the Collis et
al. (2004) survey, in which it was concluded that non-family owned companies
would be more likely to prefer voluntary audit, where it is believed that a higher
level of owner/family management would result in less desire for audit due to
the access and availability of the financial information to these parties.
Based on the above, it would be logical to accept the first hypothesis of
this study, which holds that ‘there are significant differences between different
modes of ownership structure (wholly family-owned, partly family-owned, and
non-family owned) and SMEs’ opting for voluntary audit’.

4.3 Testing Hypothesis 2: Resources

However, the results for hypothesis 1 do not fully corroborate the ‘agency theory’,
which is more relevant and applicable in a complex set-up in which the directors
have only a minor stake in the company, and, thus, may work towards maximizing
their personal gains instead of those of the shareholders. In addition, the majority

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 Audit Exemption for Malaysian SMEs: Does Ownership Matter?

of the firms in our sample (79 per cent) have only three to four shareholders.
Therefore, other factors seem to be involved, which influence the firms’ decision
to opt for voluntary audit. This conflict forms the basis for the second hypothesis
of this study, which states that a ‘Lack of SMEs’ resources is significantly related
to opting for voluntary audit’.
In view of the second hypothesis, three sub-dimensions: ‘level of services
received by SMEs’ (Service), ‘reliance on external accountants’ advice (advice),
and ‘the value derived from the audit’ (value) have been chosen for further analysis
(Kamyabi and Devi, 2011). Table 4, Table 5, and Table 6 show the results.

Table 4: Comparison Level of Services vs. Ownership

Services Service
Ownership Mean t-value p-value
Class Mean
None 3.0294
1 to 4 3.3333
NF 3.5062 -1.1900 0.1184
5 to 7 2.9310
8 to 10 2.7778
None 3.6800
1 to 4 2.6667
PF 4.1846 -4.04*** 0.0000
5 to 7 3.1600
8 to 10 2.7778
None 3.7500
1 to 4 4.0000
WF 5.5700 -2.56*** 0.0058
5 to 7 3.3333
8 to 10 3.8462
Notes: 1) N = 198. 2) None = no additional services received, 1 to 4 =
1 to 4 types of services received, 5 to 7 = 5 to 7 types of services
received, 8 to 10 = 8 to 10 types of services received

Table 4 summarizes the results of the analysis of the SMEs decision

concerning voluntary audit by mapping the mean voluntary audit decision
response for different levels of service received according to the different
ownership categories.
The results show that wholly family-owned SMEs have the highest mean
scores on services compared to partly family-owned and non-family owned
SMEs. The results are very significant at the .001 level for both partly and wholly
family-owned SMEs. At this significance level, partly and wholly family-owned
SMEs strongly favour outsourcing services. Obviously, non-family owned
SMEs do less outsourcing to auditors in comparison to partly and wholly-family
owned SMEs. This could be the result of non-family owned SMEs having
more accounting capability compared to the other two types of ownership. In

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 Engku Ahmad Khairuddin Engku Mohd Anuar, S. Susela Devi and Chan Wai Meng

fact, the resource dependency theory emphasizes the power that underpins the
outsourcing relationship. In view of the results, this possibility of a higher level of
dependency by wholly and partly family-owned SMEs on the external accountant
for accounting services could be rooted in their lack of accounting resources be
it human resources in the form of (qualified) accountants or intangible resources
as accounting expertise.
In view of the second sub-dimension, reliance on external accountant’s
advice, on a scale of 1 to 5 where 1 = strongly disagree and 5 = strongly agree,
the sampled SMEs were asked to indicate whether audit was conducted to seek
the accountant’s advice. For each respective ownership category, the mean score
for voluntary audit at each level of advice response is computed, and a t-test
conducted. Table 5 summarizes the results.
According to Table 5, there is a strong preference for voluntary audit
in the partly family-owned and wholly family-owned SMEs when the level
of reliance on external accountant advice is high at a significance level of .01
and .05, respectively. This further supports that family-owned businesses are
heavily dependent on the external accountant’s advice. Additionally, these results
corroborate the previous findings that this reliance may be due to the outsourcing
of accounting requirements, and, thus, support their need for voluntary audit as a
readily available source of accounting expertise (Keasey et al., 1988).

Table 5: Reliance on External Accountants Advice vs. Voluntary Audit and Ownership

Reliance Voluntary Audit

Ownership t-value P value
Advice Mean
Strg Dsg 4.0000 2.7400 0.0204
Dsg na
NF Undec 3.0000 0.7000 0.5000
Agree 2.8108 -1.3100 0.0988
S Agree 3.0357 0.1700 0.4327
Strg Dsg 2.6667 -0.5000 0.3333
Dsg 3.6000 0.8800 0.2132
PF Undec 3.1111 0.3300 0.3711
Agree 3.3158 1.1000 0.1426
S Agree 3.6500 3.5800*** 0.0010
Strg Dsg 3.3333 1.0000 0.2113
Dsg 4.5000 1.8400 0.2230
WF Undec 3.6667 1.7300 0.0532
Agree 3.3333 0.9700 0.1724
S Agree 3.5714 2.2800** 0.0200
Notes: 1) N = 198; 2) Strg Dsg = Strongly Disagree, Dsg = Disagree,
Undec = Undecided, S Agree = Strongly Agree

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 Audit Exemption for Malaysian SMEs: Does Ownership Matter?

Table 6: Value of Audit vs. Voluntary Audit Decision and Level of Family Ownership

Ownership Value Mean t-value P value

Hi 3.1900 1.3700 0.0880
NF
Mod 2.6400 -1.84** 0.0383
Hi 3.5900 3.59*** 0.0004
PF
Mod 2.6300 2.1700 0.9838
Hi 3.5000 2.45*** 0.0093
WF
Mod 3.7500 3*** 0.0100
Notes: 1) N = 198; 2) Hi = High average value score
4 to 5. Mod=Moderate average value score 3 to 4.
Low (less than 3) average score, which was not found

Table 6 shows the results of the voluntary audit responses for the SMEs
classified as having high and moderate value from the audit, mapped to the
respective ownership category. Based on the results, most of the wholly family-
owned SMEs perceive the value of audit as either high or moderate. In addition,
there is a significant relationship between the perceived value of the audit (both
high and moderate), and opting for voluntary audit. This being significant at the
1 per cent level shows their strong preference for voluntary audit.
Partly family-owned SMEs also perceive the value of audit as either high or
moderate, yet those who perceive the value of audit as high tend to significantly
opt for voluntary audit. This relationship is extremely significant (sig. at .0001)
and shows their high level of preference for voluntary audit.
As for non-family owned SMEs, it can be seen that they also perceive
the value of audit as either high or moderate. However, there is a significant
relationship between value of audit and opting for voluntary audit only among
those SMEs that perceive the value as moderate. The significance level here is
p<.05, which shows a weaker state of preference for voluntary audit.
Overall, only wholly family-owned SMEs have both high and moderate
audit value perceptions significantly related to voluntary audit, which shows that
this strong preference may not be eliminated by providing them with a choice.
This, however, may possibly be due to the influence of the external accountant
on the respondents’ perceptions concerning the benefits of the audit (Collis et al.,
2004). This is consistent with the earlier analysis, which finds that family-owned
SMEs rely heavily on the external accountant’s advice.
In sum, it can be seen that dimensions, such as service, advice, and value,
which represent the lack of resources of the sampled SMEs, are significantly
related to their opting for voluntary audit, albeit not in absolute ways. Therefore,
the second hypothesis is accepted as holding true concerning this sample.

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 Engku Ahmad Khairuddin Engku Mohd Anuar, S. Susela Devi and Chan Wai Meng

5. Conclusion
Based on the above findings it can be concluded that, overall, both family-related
ownership structures opt for voluntary audit, while, in contrast, non-family
owned SMEs seem to not be keen on opting for voluntary audit or are mainly
undecided. This shows their strong preference for voluntary audit and their lack
of motivation to comply with a would-be voluntary regime. These findings lead
to the acceptance of the first hypothesis of the study, which holds that ‘there are
significant differences between different modes of ownership structure (wholly
family-owned, partly family-owned, and non-family owned) and SMEs opting
for voluntary audit’. However, as the results do not fully corroborate the ‘agency
theory’ and are in conflict with the findings of Collis et al. (2004), further analysis
has been based on the resource dependency theory (RDT).
In view of the level of services and reliance of advice, it can be concluded
that, predominantly, family-owned SMEs (both wholly family- and partly family-
owned) tend to outsource their accounting services to audit firms. In fact, they
are heavily dependent on the auditing services to increase the confidence, quality,
credibility, and assurance of their financial information. This reliance may be due
to the outsourcing of accounting requirements, and, thus, support their need for
voluntary audit as a readily available source of accounting expertise (Keasey et
al., 1988). Yet, as far as the perceived value from auditing is concerned, almost
all SMEs view audit value as either high or moderate. However, mostly, SMEs
with a family structure have a strong preference for voluntary audit when the
perceived value is high.
In short, in the case of Malaysian SMEs, it seems that, possibly, a higher
level of dependency by wholly and partly family-owned SMEs on the external
accountant for accounting services could be rooted in their lack of accounting
resources be it human resources in the form of (qualified) accountants or
intangible resources as accounting expertise. In fact, the resource dependency
theory emphasizes the power, which underpins the outsourcing relationship.
Therefore, it would be the case here that the resource dependency theory could
provide a better explanation for the tendency of Malaysian family-owned SMEs
to opt for voluntary audit. Their preference for audit is mainly due to their lack
of resources as compared to SMEs with non-family related ownership. Thus, the
second hypothesis of the study, which holds that a ‘Lack of SMEs’ resources is
significantly related to opting for voluntary audit’, is supported. These conclusions
also lead us to several practical implications.
First, this research provides empirical evidence for audit policy makers so
that they can make a more plausible decision concerning the audit exemption
regime. This research shows that firms that perceive benefits from audit have
indicated that they will opt for voluntary audit. This may spur SMPs to be more
innovative and offer more value added services. These findings can be of value to
other countries, which are experiencing the same undecided or pending situation.

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 Audit Exemption for Malaysian SMEs: Does Ownership Matter?

Second, the results spotlight a lack in the number of qualified accountants

in Malaysia as an emerging economy, therefore, education bodies and curriculum
designers should deliberate over the gap between demand and supply and
formulate a pragmatic solution to close this gap.
Third, if SME audit becomes optional and SMEs become independent, a
large number of SMPs will suffer from a huge revenue cut, which, in turn, will
lead to other issues, such as downsizing, filing for bankruptcy, and dissatisfaction.
Alternatively, auditors will be compelled to provide genuine value added services
to remain competitive. Consequently, the businesses that perceive benefits will
continue to seek out external accountants. Thus, we concur with Chan (2012) that
it is timely for auditors to review their role to ensure that audit remains relevant
and continues to be a vital link in the financial reporting value chain. We believe
that there should be a demand for audit even by companies that are exempted
from the requirement. The small audit firms that produce quality audit work
should be able to survive.
This research also opens new avenues for further research to focus more
deeply on the ownership structure of Malaysian SMEs. This can be done through
conducting large-scale studies, which are of more confirmatory value and their
results more generalizable. Indeed, the decision to introduce audit exemption
requires further detailed studies concerning the consequences of and implications
for the national economy. In addition, the decision has to be made after careful
consideration and consultation with all stakeholders. Therefore, triangulation
among SMEs, SMPS, policy makers and other stakeholders is necessary.
In conclusion, in answer to the question: “does ownership matter?”, it does,
because, in the context of an emerging economy like Malaysia, smaller family
owned companies lack the necessary resources and look towards audit to provide
assurance to the owners themselves.

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