Difficulties affecting the SME audit market

Audits have many benefits, providing detailed overviews of business health. However, ISAs are hard to scale and the process can be onerous for small and medium enterprises.

The Financial Reporting Council (FRC) recently pinpointed several challenges affecting the SME audit market. It has lauched a consultation on a Practice Note to support auditors as they apply International Standards on Auditing (ISAs) UK when auditing smaller and/or less complex entities.

But while the regulator’s remedy in the form of a new Practice Note providing guidance is a welcome step, it still has a way to go to address auditors’ concerns.

Findings from the FRC’s study into the SME audit market published in July highlighted widespread concerns among auditors of a lack of scalability and proportionality in applying International Standards on Auditing (ISAs) that do not meet the needs of smaller businesses.

Fear of failure to comply

Steve Collings, a director at Leavitt Walmsley Associates, says the current model for SME audits in terms of cost and efficiency is “not particularly sustainable at the moment because the model is a ‘one-size-fits-all’ approach to auditing.”

“Very few practitioners are aware that the ISAs (UK) are scalable and where they do become aware of the scalability provisions, there is nervousness in scaling them to fit an SME client,” Collings says.

This, he says, is “most likely due to fear of not complying with the ISAs (UK) and receiving criticism from a professional body monitoring inspector.

Additional workload is a drag

The FRC found that many smaller audit firms believe that regulators expect them to do unnecessary work and that the supervisory environment “prioritises compliance and exhaustive documentation over auditors’ professional judgment.”

Therefore, 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.

Shakeups could help

A more proportionate approach to audit supervision for lower risk and smaller audits would ease pressure on the SME market by reducing costs and encouraging innovation by audit firms and smaller practitioners.

“As SMEs make up much of the marketplace, it’s important to determine the audit approaches that suit them best. While efficiency is important, maintaining a robust and reliable audit must remain the top priority”, Kate Taylor, an audit partner at DSG Chartered Accountants, says.

Consulting on auditing guidance

To assist auditors, the FRC is consulting on a Practice Note published alongside the study to help firms apply ISAs more effectively when auditing smaller or less complex entities.

Typically, smaller and less complex entities are those which have

• ownership concentrated in a small number of individuals
• operations with few sources of income
• simple internal controls and business processes.

The guidance focuses on scalability, allowing auditors to tailor their approach when auditing smaller entities that often have simpler business models, fewer complex transactions and different risk profiles compared to large corporations.

It promoted a risk-based audit approach that, along with the scalability provisions in ISAs (UK), the FRC hopes will allow for the better tailoring of an audit to an audited entity and more efficient audit approach.

Paul Wilson, Policy Director at the Federation of Small Businesses, says the FRC has made several “sensible and practical suggestions to bear down on regulatory costs for SMEs”.

“Small businesses have a tendency to over-comply when they are unsure how rules should be interpreted, so extra guidance on what compliance could look like should avoid wasted time and help cut costs,” Wilson says

Practice Note details

The Practice Note, which is open for consultation until October, provides guidance for planning an audit of financial statements, including determining materiality and the use of experts.

It also outlines the overall approach to risk assessments, which are a fundamental aspect of any audit and the primary method to deliver a robust but proportionate audit focused on the key risks relevant to the financial statements of a specific entity.

 “When auditing SMEs, the process should be tailored to their specific needs. Effective planning is essential to identify key risk areas early, so auditors can allocate time where it delivers the most value,” Taylor says. “This allows efficiencies to be achieved by reducing focus on areas of lower risk without compromising audit quality.”

Materiality informs the entire audit, from the risk assessment to the design of responses to the evaluation of misstatements. So, setting an appropriate materiality is therefore key to the proportionality of the audit.

“It is based on risk assessment,” Collings explains. “If I am auditing a particularly complex group, for example, I may use more than one performance materiality level for specific aspects of the group. I might also decide to use other elements of the financial statements for setting materiality, based on risk.”

Risk of material misstatement

It is important to remember that the objective of the auditor is the same regardless of the nature of the audit: to identify and assess the risks of material misstatement at the financial statement.

The guidance notes that smaller or less complex entities may have ownership structures or operate in segments of the market such that the users of their financial statements may be less sensitive to misstatements than for some other entities.

And audit documentation associated with the accounting system is also likely to be relatively simple, focusing on how the main transaction cycles operate and highlighting the risks of material misstatement that arise from the nature of the systems in place.

Collings says that, where the risk of material misstatement is lower, he would be comfortable scaling back his audit approach – even relying on tests of controls to reduce substantive procedures.

“There is little to be achieved in over-auditing something where the risk of material misstatement is considered low, but I’d always try and justify my approach within the audit plan so it’s clear which angle I am coming from,” Collings says.

What’s coming next

Overall, Collings says the draft Practice Note is a good “starting point”.

“It could benefit from some more detailed guidance on scalability – especially as the FRC has indicated this is one of the concerns they have and why auditing has become more costly and off-putting to many smaller practitioners,” he says.

The consultation, which is part of the FRC’s year-long SME campaign, closes on 17 October 2025. You can read the draft Practice Note on the FRC’s site here.

AAT Comment offers news and opinion on the world of business and finance from the Association of Accounting Technicians.