Will SME audits get easier?

On 4 June 2025, the Financial Reporting Council (FRC) held a webinar International Standard on Auditing for Less Complex Entities. This webinar was part of the FRC’s current campaign on providing support to UK SMEs to access audit services.

In recent years, audit firms involved in the audit of SMEs have complained about the proportionately and complexity of the International Standards on Auditing UK (ISAs (UK)). Seemingly, a ‘one-size-fits-all’ approach to auditing does not work and this has resulted in the costs of audit becoming excessive. Indeed, a lot of SME clients view the audit as nothing more than an expensive compliance exercise when, in reality, there are inherent benefits to an audit. From an audit firm perspective, audits have become expensive and more rigorous, and this seems to be one of (if not ‘the’) main reason why smaller audit firms are stepping away from offering audit services.

One auditor I spoke to during the writing of An Auditor’s Guide to Auditing Financial Statements in the UK said ‘I will be glad to retire from all of this. Auditing has turned into nothing short of an expensive nightmare which you cannot seem to wake up from.’ That’s quite a scathing comment, and variations of which seems to reverberate in many audit firms.

On 20 May 2025, the FRC published a two-page factsheet titled What is an audit? This resource provides a high-level overview of an audit which covers:

• The concept of ‘reasonable assurance’
• Materiality
• The purpose of an audit
• The value that an audit brings to the entity
• Principles common to all audits

This educational material is designed to help SMEs gain a better understanding of what an audit is and how it is carried out. But the question that many practitioners are asking is ‘will SME audits get easier?’

The FRC webinar gave some insight as to what audit firms can expect to be issued by the regulator to provide support to SMEs and their auditors. Some in the auditing profession would like the FRC to adopt the International Standard on Auditing for Audits of Financial Statements of Less Complex Entities (ISA for LCE). The ISA for LCE is issued by the International Auditing and Assurance Standards Board and addresses the unique needs of audits of smaller and less complex businesses. However, this standard brings its challenges, some of which I will discuss as follows:

Scope of the ISA for LCE

The ISA for LCE can only be used in jurisdictions that have adopted the standard (the UK has not and is unlikely to). Where the ISA for LCE has been adopted, it is the nature of the business that determines whether, or not, the standard can be used. The question that must be asked is ‘Are the business activities, organisational and ownership structures, finance function, technology, accounting and reporting less complex?’ If the answer to this question is ‘yes’, ISA for LCE can be used; otherwise it cannot. In practice, many smaller audit clients still have inherent complexities so they would be ruled out from using the standard anyway.

In addition, the ISA for LCE cannot be used by public interest or listed entities or medium-sized entities. In the UK, companies that qualify as small or micro can claim audit exemption and the company size thresholds have been increased for accounting years commencing on or after 6 April 2025.

Group audits

ISA for LCE cannot be used if the audit is an audit of group financial statements and:

• Any of the group’s individual entities or business units are public interest entities or listed entities, financial or insurance institutions; or
• Component auditors are involved. The exception here is when the component auditor’s involvement is limited to circumstances in which a physical presence is needed for a specific audit procedure for the group audit, such as attending the inventory count (essentially the involvement of a component auditor should be limited to the performance of a specific audit procedure).

Complex issues

ISA for LCE does not address complex issues. This is because the requirements of the standard have been designed to be proportionate to the typical nature and circumstances of an audit of an LCE. For example, ISA for LCE would not be appropriate in the following situations:

• When considering the organisational structure, if the entity has a large key management team with many individuals involved in managing different areas of the entity, ISA for LCE will not be appropriate.
• If management rely heavily on complex system-generated reports in their controls, the standard will not be appropriate.
• The financial statements include an accounting estimate(s) which is known to be associated with complicated transactions, or accounting entries that involve significant subjectivity in judgements, complex calculations or complex modelling.

The nature of ISA for LCE would effectively mean the scope of entities able to use the standard would be quite narrow.

What can we expect from the FRC?

I suspect it is unlikely that the FRC will adopt ISA for LCE and even if it did, the costs involved in carrying out an audit would not see much in the way of reduction. In addition, there is very minimal application material supporting the ISA for LCE and one of the concerns in this respect would be consistency in applying the standard.

If adoption of the ISA for LCE is ruled out by the FRC, we can expect a Practice Note to be issued. Of course, this would not be the first time that a Practice Note has been issued in respect of smaller audits as we did have Practice Note 26 Guidance on Smaller Entity Documentation that was withdrawn in 2018.

Practice Notes are issued by the FRC to help auditors to apply the ISAs (UK) to different sectors and the FRC is expected to issue one on SME and less complex entity audits.

As mentioned earlier in the article, one of the most common criticisms by SME auditors on the ISAs (UK) is their proportionality to the audit. Scalability is an issue faced by all SME auditors; however, the FRC did acknowledge that the ISAs (UK) do have scalability provisions embedded within them, which should be used accordingly.

For example, if we look at ISA (UK) 540 Auditing Accounting Estimates and Related Disclosures, scalability is addressed in paras A20 to A22. Para A20 acknowledges that some accounting estimates may be less complex and may be subject to, or affected by, estimation uncertainty, complexity, subjectivity, or other inherent risk factors to a lesser degree and there may be fewer identified controls in the control activities component. Where this is the case, the paragraph acknowledges that the auditor’s risk identification and assessment procedures are likely to be less extensive and may be obtained primarily through inquiries of management and simple walk-throughs of management’s process for making the accounting estimate.

In contrast, however, an accounting estimate may require significant judgement on the part of management and the process involved in arriving at the estimate may be complex and rely on complex modelling – such as construction contract revenue. In such cases, the auditor’s risk assessment procedures will be different (typically more extensive).

The scalability provisions in the ISAs (UK) should be used where appropriate. However, some auditors often feel that the use of such provisions might involve ‘cutting too many corners’ resulting in insufficient and/or inappropriate audit evidence. This is where a Practice Note may guide the auditor on how the scalability provisions can be applied in an audit without compromising audit quality.

In any event, it would seem that support is needed in the area of scalability to ensure that the audit is still carried out in compliance with the ISAs (UK).

Risks

One of the key aspects of planning is risk assessment and the audit procedures developed when devising the audit strategy and the resulting audit plan are based around risk. Auditors are required to carry out separate assessments of inherent and control risk and devise their procedures in accordance with their risk assessment.

As the discussions around SME audits have progressed in various settings, it has become apparent that a lot of audit firms are carrying out their audits using a tick-box approach. This is probably symptomatic of the fact that the ISAs (UK) are vast. Audit firms do use the various off-the-shelf audit programs which have different methodologies, but a concern is that auditors are simply following procedures on an audit program to just get the program completed. This can result in over-auditing if the audit program is not tailored to be client-specific and reflect the auditor’s assessment of risk of material misstatement. Again, linked directly to this are the scalability provisions in the ISAs (UK) which should be taken advantage of, where practical.

Conclusion

The FRC is actively trying to provide resources to SMEs and their auditors and while its potential solution may not be what everyone wants, it is a step in the right direction to address the current problems. A Practice Note for SME audits is likely to be issued in due course and hopefully this will provide much needed guidance to audit firms to help them carry out a more effective audit which will benefit both the firm and th

Category: Audit