Auditing smaller and less complex entities in the UK

In July 2025, the Financial Reporting Council (FRC) issued an Exposure Draft of a Practice Note Guidance for audits of smaller and/or less complex entities. This draft Practice Note (PN) has been developed following the launch of a year-long campaign in January 2025 by the FRC to help SMEs access audit services and reduce reporting burdens where possible.

The draft PN contains non-prescriptive guidance that is intended to assist auditors apply the ISAs (UK) in specific circumstances and sectors.

Initially, there were discussions concerning the possibility of the UK adopting the International Standard on Auditing for Audits of Financial Statements of Less Complex Entities (ISA for LCE) issued by the International Auditing and Assurance Standards Board. The FRC had previously stated there were no plans for the UK to adopt the ISA for LCE and it would now seem that any plans to adopt the ISA for LCE in the future are off the table.

One of the main objectives in producing a PN for audits of small and/or less complex entities is to enable audit firms to deliver effective and high-quality audits which focus on risk rather than compliance. The draft PN achieves this by assisting firms to take advantage of the scalability provisions in the ISAs (UK). Many firms use off-the-shelf audit programmes to carry out audit work for SME clients, which are invaluable tools. However, what seems to have happened over the years is that audits have become more a ‘tick-box’ exercise and this is likely to have happened because of the sheer volume of the ISAs (UK).

Many auditors acting for clients in the SME sector have complained that having one set of UK auditing standards for all audit clients, regardless of size and complexity, is disproportionate. This, in turn, results in the cost of audit becoming too high, often resulting in the audit becoming loss-making, and clients themselves are left questioning what they are paying for, other than merely a compliance exercise. The FRC has stated that it is committed to quality audits based on a single set of standards and the PN will assist in their application in a proportionate and scalable way.

Audits nowadays are carried out on a risk-based approach; hence the focus should be on the identified risks of material misstatement of the client’s financial statements. Simply following a generic audit programme often overlooks those risks meaning the audit becomes compliance-based as opposed to risk-based. This is something the FRC and professional bodies are aiming to resolve.

The FRC has clarified that the ISAs (UK) are scalable. In other words, the audit approach should be tailored to suit the nature, size and complexity of the audit client. Many SMEs are likely to fall into the ‘less complex’ criteria, but care will need to be taken to ensure indicators of complexity are properly considered. The PN acknowledges that typically smaller and/or less complex entities are those where:

• ownership of the entity is concentrated in a small number of individuals (sometimes a single individual) who are actively involved in managing the business; and
• the operations are uncomplicated with few sources of income and activities; and
• business processes and accounting systems are simple; and
• internal controls are relatively few and may be informal.

Challenges identified by the FRC

In its various roundtables, the FRC received feedback from stakeholders about the challenges identified in applying the ISAs (UK) for clients in the SME sector. Some (but not all) of that feedback is as follows:

• The length of the ISAs (UK) has tended to increase over time, and this poses challenges for smaller audit firms operating in the SME sector.
• There is a risk that proportionality and scalability provisions are not sufficiently prominent.
• There is a perceived lack of clarity as to what (and how) much needs to be documented when auditing a smaller and/or less complex entity.
• Paragraphs containing specific provisions for smaller entities (where presented) are unhelpful in understanding scalability and proportionality of the requirements.
• The provisions in ISA (UK) 315 (Revised July 2020) Identifying and Assessing the Risks of Material Misstatement may lead to an over-engineered risk assessment for non-complex entities. In turn, this adds unnecessary complexity in obtaining an understanding of the client’s system of internal control.
• Fraud aspects governed by ISA (UK) 240 The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements are considered to be too onerous than what would otherwise be appropriate in the circumstances.

Other feedback related to the compliance-driven approach to the ISAs (UK), (which has been mentioned above); the audit of accounting estimates; and going concern issues.

Applying the PN

It should be emphasised that the draft PN does not change or remove any requirements of the ISAs (UK). Instead, it is intended to provide audit firms with the confidence to make full use of the scalability provisions as well as professional judgement in determining the overall audit approach.

The PN includes guidance that is intended to:

• Clearly identify areas where auditors should apply professional judgement when applying the ISAs (UK) for smaller and/or less complex entities.
• Assist practitioners in understanding the core objectives of the more complex standards, such as ISA (UK) 315.
• Provide examples of how the ISAs (UK) can be applied in practice in less complex audits.
• Give an indication of appropriate audit documentation.

Dates

The FRC is inviting written comments on all aspects of the consultation and the draft PN by 17 October 2025. Comments should be emailed to AAT@frc.org.uk (marked for the attention of James Ferris). The FRC has clarified that respondents need not respond to every question in the Invitation to Comment document and can focus on the issues they consider to be of greatest importance. However, the FRC is interested in responses to questions 1-4 (for convenience, these questions are reproduced below):

1. Do you support the development of the PN, and do you believe it will help give practitioners the confidence to apply the ISAs (UK) in a scalable and proportionate manner for the audits of smaller and/or less complex entities?
2. Do you believe the PN addresses the issues arising in the SME market sector when it comes to audit?
3. Are there other ISAs (UK) or specific requirements within ISAs (UK) that you believe this PN should provide guidance in their application to the audit of small and/or less complex entities?
4. Are the examples included within the PN and the Appendix helpful or could they be enhanced? Are there other scenarios that we could include in the final version of the PN?

In terms of the effective date of the PN (when issued), as PNs do not change or go beyond the boundaries of the ISAs (UK), the PN will become effective immediately once issued by the FRC.

A link to the consultation page and the draft PN can be found by clicking on this link.

Category: Audit