Audits of SMEs up for review

Over the last few years, auditing has become increasingly difficult. A lot of this difficulty and extra work has been as a result of the Financial Reporting Council’s (FRC) attempts to restore confidence in the auditing profession following recent high-profile corporate scandals. As auditing standards become more rigorous in nature, the costs of doing an audit increase as well. At the minute fee pressure is being felt across many firms, particularly with the recent increase in employer National Insurance contributions, and audit clients are also feeling the impact.

A lot of firms at the smaller end of the scale that perhaps had a handful of audit clients have taken the decision not to offer audit services because auditing has become unprofitable and very demanding. Indeed, the latest Key Facts and Trends in the Accountancy Profession issued by the Financial Reporting Council (FRC) in September 2024 confirms that the number of audit firms registered with Recognised Supervisory Bodies continues to see a downward trend. As at 31 December 2023, there were 4,038 registered audit firms compared to 4,310 in 2022 and 4,745 in 2021.

High-profile corporate scandals involving large audit firms have not helped the direction of travel for auditing either. Indeed, many clients at the smaller end of the scale who are required to have an audit because they have breached the audit exemption thresholds question the benefits of having an audit, especially in light of Carillion, Patisserie Valerie and now Thomas Cook. Most clients who fall into the small-medium sized entity (SME) category tend to view the audit as nothing more than a compliance exercise akin to ‘… having to pay your increased car insurance bill because the law requires it’.

This isn’t really how auditing was intended to be viewed, but has the auditing profession over-regulated itself, particularly for audits of SMEs?

All audit firms are required to have periodic inspections of their audit work to ensure that high standards are being maintained. Most audit firms receive a satisfactory outcome, but some do not and for those that don’t, there tends to be a variety of reasons why the outcome is unsatisfactory. Whatever the reason, it generally boils down to non-compliance with either the International Standards on Auditing (UK) (ISAs (UK)) or the FRC’s Ethical Standard.

Having met several thousand auditors over the years on the lecture circuit, there does appear to be one underlying criticism of the auditing profession that is common among most auditors of SME clients: the ISAs (UK) are too complicated. In addition, many auditors complain that the approach to audit work nowadays is more of a ‘tick box’ style approach given the sheer number of audit procedures that firms are required to carry out in order to gather sufficient appropriate audit evidence.

I remember a (now retired) lecturer once saying to me ‘auditing used to be accountancy plus common sense.’  I suspect there may be many practitioners nowadays that would agree with that comment. However, the FRC has begun to look into the issues faced by auditors and SMEs as part of a broader campaign to support SMEs in accessing audit services.

Consultation on SME audit work

In February 2025, the FRC issued a consultation document, Small and medium-sized enterprises market study – Invitation to comment.

This consultation document acknowledges that SMEs form a significant part of the UK economy, representing 99% of the private sector business population. They employ around 16.6 million workers and have a shared turnover of £2.75 trillion (52% of the shared total).

The FRC acknowledges that it is aware of potential issues associated with reporting and audit requirements that may result in addition burdens being placed on SMEs. To that end, the FRC’s market study has four areas of focus:

• How the audit market is working for SMEs, including any burdens arising from reporting and audit requirements.
• Market forces driving the consumption of audit services by SMEs.
• Challenges auditors experience when auditing SMEs.
• Forthcoming market, legislative or regulatory developments which the FRC should be considering as part of its study.

The FRC has held a number of roundtable events and I was involved in one with ACCA. Consistent with what I strongly suspected, the main criticism was the proportionality of the ISAs (UK). ACCA’s response to the FRC’s market study can be found here.

There are many practitioners and commentators that are of the opinion that the ISAs (UK) are disproportionate for SME clients in a number of areas. This is perhaps symptomatic of them being written from a ‘think big first’ approach rather than a ‘think small first’ one. Hence, the stance is always from a large entity perspective.

For example, ISA (UK) 315 Identifying and Assessing the Risks of Material Misstatement is considerably voluminous. Excluding the Conforming and Consequential Amendments to Other ISAs (UK), it is 106 pages long. While most of that is the Application and Explanatory Material, which provides a lot of examples to articulate the requirements, it can be overwhelming for an auditor of an owner-managed business to deal with that standard. The wording of the ISAs (UK) can also be unclear and ambiguous if you’re not used to dealing directly with the ISAs (UK) on a regular basis. This is perhaps why auditors of SME clients tend to rely on their audit programmes to complete audit work, which often results in a tick-box approach.

Has the IAASB got there already?

The International Auditing and Assurance Standards Board (IAASB) issued International Standard on Auditing for Audits of Financial Statements of Less Complex Entities (ISA for LCE) in December 2023. It becomes effective for jurisdictions that have adopted it for audits beginning on or after 15 December 2025.

The FRC has previously stated that there is no intention by the UK to adopt ISA for LCE on the grounds that the UK already has audit exemption thresholds for small entities. These have, of course, recently been increased for accounting years commencing on or after 6 April 2025.

Should the FRC revisit the decision not to consider adopting ISA for LCE during the development of a potential solution to auditing an SME client? I would imagine there would be a lot of commentators and SME auditors that would welcome such a standard. While ‘less complex’ doesn’t mean ‘small or medium-sized’, it could perhaps pave the way for SME audits to be more efficient and serve to increase standards in the quality of audit work carried out by smaller firms.

Whichever route the FRC goes down in potentially making a solution available to the complexities attached to auditing an SME client, I think the first issue would be looking at the proportionality of the ISAs (UK) in the context of SME audits. Many audit practitioners find them overwhelming, and the large entity focus of them generally make them very costly to apply. While there must be a rigorous regime underpinning audit work, I suspect that the costs of applying the ISAs (UK) to SME audits far outweigh the benefits in many areas. This, in turn, results in audits becoming loss-making, which means firms decide to withdraw offering audit services which shrinks the audit market and eventually pushes up fees for clients.

Conclusion

The comment period on the market study closed on 25 April 2025 and the FRC will now consider the results with a view to potentially coming up with a solution to the problems inherent in auditing SME clients. Whether we see a (welcomed) scaling down of the standards to befit an SME remains to be seen, but at least the FRC are listening to the concerns of auditors of SMEs and is trying to do something about it. What that something will look like is currently unknown.

Category: Audit