In its recent SME audit market study, the Financial Reporting Council (FRC) pinpointed the key pressures facing auditors of SMEs: a lack of scalability and proportionality in auditing standards, patchy technology adoption and persistent resource constraints. Few in the profession would disagree with this diagnosis.
But while the FRC’s proposed remedy – a new draft practice note offering guidance on how to apply International Standards on Auditing (ISAs) in a more proportionate way – has been welcomed as a helpful step in clarifying how UK ISAs can be tailored to SME audits, practitioners warn that it provides limited reassurance.
‘Many smaller firms believe regulators expect them to prioritise compliance over professional judgment’
‘The practice note is there as guidance on how to apply these standards. What it can’t do is remove any of the requirements,’ says Catherine Hardinge, an audit partner and head of compliance at Price Bailey. ‘I don’t think it will give firms enough confidence to change their audit approach, because from a regulatory point of view we still need to demonstrate that we are complying with the requirements.’
Compliance pressure
The emerging findings from the FRC study, published in July, revealed that many smaller audit firms believe regulators expect them to do unnecessary work and prioritise ‘compliance and exhaustive documentation over auditors’ professional judgment’.
Many firms expressed the view that audits – irrespective of size and complexity and whether they are statutory audits or contractually agreed work relating to non-statutory audits – were expected to meet the same standards and were inspected in the same way.
‘The FRC has noticed that the market is shouting up about it’
Steve Collings, a director at Leavitt Walmsley Associates, says there are some ISAs ‘that are disproportionate in some respects’ and have been ‘designed from a “think big first” approach’ – particularly UK ISAs 315 (risk assessment), 240 (fraud), 600 (groups) and 570 (going concern).
‘Very few practitioners are aware that the ISAs are scalable,’ Collings says, ‘and where they do become aware of the scalability provisions, there is nervousness in scaling them to fit an SME client.’
Time for change
In response, the FRC is consulting on guidance for the audits of smaller and less complex entities and how best to achieve them consistently. It is also working with supervisors to develop a more proportionate supervisory approach to SME audits.
‘It can be difficult to apply the ISAs as they are in a proportionate way,’ says Ben Sheldon, senior statutory auditor in Azets’ assurance practice. ‘It is very welcome that the FRC has got a lens on this. Clearly, it has noticed that the market is shouting up about it.’
‘It gives SME auditors confidence in being bolder on materiality and risk assessment’
The draft practice note, which is being consulted on until 17 October, provides guidance on audit planning and materiality, along with risk assessments, including going concern, material misstatement, internal controls, and accounting systems and processes.
It aims to help auditors tailor their approach when auditing smaller entities – which often have simpler business models, fewer complex transactions and different risk profiles compared to large corporations – by providing examples of how the auditing standards can be applied in practice in less complex audits.
Responding to the consultation, ACCA suggests that the focus of the advice ‘should be on complexity rather than size given that an entity may be large in size but still be less complex. By focusing on complexity rather than just size, any initiatives by the FRC to address the scalability issues with the UK ISAs will be likely to help a much larger number of firms and practitioners.’
Sheldon says the practice note ‘will help design a more proportionate audit’ if it gets fully implemented, as small changes to areas such as risk assessment, materiality and IT control assessment could add up to quite a big difference incrementally.
‘When you take all those bits and you add them up, that could result in an audit product that is a lot more proportionate to an SME,’ Sheldon says. ‘The practice note may give SME auditors some confidence in being bolder on materiality and risk assessment.’
Going concern
The practice note provides several examples of assessing going concern – including cashflow forecasts, compliance with regulations, and professional judgment – along with examples of group audits and accounting estimates in the context of internal controls.
Sheldon notes that the ISA for going concern can be difficult to apply proportionately, whereas the new practice note ‘could give auditors more confidence in designing a better approach, being bolder in designing a more appropriate response to a risk rather than a check-box exercise.’
Auditors are screaming out for a dedicated LCE auditing standard
However, Hardinge says that although the examples are helpful, they are restricted to individual elements, which limits how much comfort they provide to auditors in scaling back their approach.
She cites ISA 315 as a particular challenge for a lot of firms because SME clients don’t have robust systems, controls and complex IT structures, yet the standards ‘require auditors to document and assess these in detail’.
Collings says: ‘There needs to be a bit more put in there that helps to articulate exactly how firms can apply the practice note properly, such as more detailed examples of scalability. It’s getting there, but I don’t think it’s quite there yet.’
Falling short
And others think the practice note falls short of what the auditors are really screaming out for – a dedicated auditing standard for less complex entities (LCEs).
Sheldon says Azets asked the FRC to consult on implementing a dedicated LCE standard, arguing that the absence of one – despite the practice note – ‘can muddy the waters and make auditors nervous’.
He adds: ‘We would prefer that to a practice note, and I don’t think we are the only ones. You still might have auditors who are nervous with just a practice note whereas an LCE would perhaps give that confidence.’
In its response to the FRC market study, ACCA says it would be ‘in the public interest’ for the FRC ‘to set out clearly the basis for its decision not to adopt the IAASB’s International Standard on Auditing for Audits of Financial Statements of Less Complex Entities’.
Hardinge says: ‘A number of us recognise that the international standard that has been issued is not perfect, but it is a step in the right direction. The fact that the FRC hasn’t done a proper consultation is really frustrating.’
More information
See ACCA’s response to the consultation
