Key takeaways

• UK SMEs are being pulled into audits through acquisitions and supply chain pressures.
• ISAs are quite difficult to adapt to smaller entities.
• Firms need to keep in mind the lower materiality threshold, and the likely lack of internal controls.
• Auditors of SMEs suggest starting balance testing early and taking larger sample sizes, among other things.

Five SME adjustments

1. Expect a lower materiality threshold

SME audits, even of very small entities, require significant time. One of the trickiest things to address is materiality, which sets the level at which errors or omissions in the financial statements could influence decisions.

“For smaller businesses, that threshold, which is usually a function of revenue, profit or the balance sheet, is lower, meaning auditors often need to review a higher volume of smaller transactions,” says Schmitt.

The introduction of Practice Note 28 is a step in the right direction, he adds, but he stresses this is only guidance and doesn’t remove any of the requirements from the main standards. 

As a result, auditors of SMEs have to spend significant time adjusting for the risks and limitations within an SME client.

2. Start opening balance testing early

Graham says Armstrong Watson places a strong emphasis on communicating with the SME about what’s involved. “We try to narrow the expectations gap, explain the structure of a statutory audit, and outline the access and information we will need to be able to conduct an efficient audit process,” she says. “We can undertake opening balance testing early, which means that areas of complexity, the control environment - or lack of it - and any areas of non-compliance and areas of higher audit risk, can be flagged before we start the main fieldwork.” 

3. Review more transactions

Applying the standards to SMEs requires a very different skillset to larger organisations. “Communicating what the financial reporting requirements are is important, and clearly setting out the audit evidence required along with why it is needed is often necessary,” Schmitt says. 

“Auditors also often find themselves unable to test controls in SMEs and instead need to review large samples of transactions and balances to help them form their opinion on whether the accounts show a true and fair view.”

4.Get specialist input if needed

Where specialist technical issues are identified, a firm may choose to bring in independent support. “Where this occurs, we ensure clear safeguards are in place to avoid self-review or management responsibility threats, including the use of separate teams in service lines external to the audit team,” Graham says. “This ensures that the auditor does not assume management responsibility and that independence is not impaired.”

Schmitt adds that many audit firms, including Price Bailey, use sector specialists to determine the technical complexity of SMEs. 

5. Use technology to speed up the review process

Technology is also starting to help relieve some of the additional workload that is required with SME audits, believes Schmitt. “Technology, including integration of AI into audit methodology, is assisting with substantive audits, assisting auditors to review large volumes of data and assisting with extensive substantive audit testing,” he says. “This is clearly the direction of travel, and something that the profession is embracing.”