Guidance, in the form of a draft Practice Note (PN), has been put forward as part of a package of Financial Reporting Council’s (FRC) proposals to address challenges in the SME audit market, as set out in its SME Audit Market Study Emerging Findings (the Findings).

The Findings and PN were released concurrently for public comment in July 2025. They are  part of the FRC’s year-long campaign to enhance SME access to audit services, thereby improving their ability to grow and scale. You can read ICAEW’s response to draft PN here and its response to the Findings here.

ICAEW agrees with most of the FRC’s market study findings but is not convinced that the proposed remedies are likely to benefit SMEs or their auditors. The draft PN requires substantial improvement if it is to be effective. As ICAEW notes, the ISAs as they stand they are currently only scalable with considerable difficulty, and some artifice.

ICAEW also recognises the pressing need for a proper, FRC-led discussion about the ISA for LCE: the International Auditing and Assurance Standards Board’s (IAASB’s) standalone standard for the audit of less complex entities, which is not covered by the consultations.

ICAEW is clear that in the absence of significant improvements to the draft PN together with its re-exposure, and an FRC-led public discussion on how the ISA for LCE might be adapted for use in the UK, ICAEW does not support publication of the PN. As it stands, there is a risk that the PN may confuse rather than clarify how auditors of smaller and less complex entities are expected to apply the ISAs, and create expectations about improvements to SME audits that cannot be met.

Challenges in the SME audit market

SME audit issues identified by the Findings include a perceived lack of scalability both in auditing and ethical standards, and in the wider regulatory environment.

These findings are no surprise. ICAEW has long called on the FRC to address the lack of scalability in the ISAs, which results in increased costs to SMEs without proportionate benefits.

The FRC’s proposed responses to the lack of scalability are to:

• facilitate discussions with recognised supervisory bodies (such as ICAEW) and other stakeholders, to improve understanding and application of the Ethical Standard and to explore how a more proportionate supervisory approach can be achieved; and
• develop and expose a Practice Note to provide guidance for audits of smaller and less complex entities.

ICAEW’s responses emphasise that, if effective guidance is to emerge from these actions, the FRC itself must play an active role in future discussions that it currently plans only to facilitate. Without the FRC in the room, discussions will have limited value.

The guidance

Practice Note 26 (PN 26), was withdrawn by the FRC in 2018. The draft PN is wider in scope than PN 26 but it is still not intended to replace the full suite of ISAs. It is a guidance document to be read in conjunction with the standards.

ICAEW disagrees with the FRC’s assumption that the ISAs are scalable and proportionate, and that practitioners need only ‘take advantage of the opportunities for scalability in the (…) ISAs.’

ICAEW argues that practitioner inefficiency and misapplication of the ISAs, to the extent that they exist, are not the root cause of challenges in the SME audit market. The real issue lies in the ISAs themselves.

A PN cannot remove or alter any ISA requirement, and it is for this reason that ICAEW only supports the publication of the PN on condition that the FRC improves and re-exposes it, and initiates and leads a public debate on how the ISA for LCE might be adapted for use in the UK.

There are limitations of the ISA for LCE as it stands. It is not a silver bullet. Nevertheless, ICAEW and others strongly disagree with claims that the UK has no need for it because of audit exemption, or that it cannot be made fit for purpose in the UK. The FRC should not ignore growing stakeholder support for a discussion of the ISA for LCE.

The draft PN requires significant improvement if it is to be of value to SME auditors. At present, it lacks high-quality practical examples in key areas including ISA (UK) 315 on risk assessment and ISA (UK) 540 on the audit of estimates.

It contains excessive verbatim repetition of ISA requirements without scaling and, unrealistically, suggests the use of tools such as ‘free-form planning memoranda’. In practice, these memoranda are rarely – if ever – used because of excessive complexity in the ISAs as they apply to SME audits, and the inevitable regulatory challenge.

“We appreciate the FRC’s efforts and agree with its objectives, but are not convinced that the proposals, particularly in relation to the Practice Note, address the root causes of the problems in the SME audit market.” says Katharine Bagshaw, ICAEW Senior Manager, Auditing Standards, Audit and Assurance. “Among other things, we need a proper and holistic discussion about the ISA for LCE. It isn’t perfect but considering how it might be adapted for the UK could be an important first step towards a healthier SME audit market. ICAEW stands willing to contribute to an FRC-led debate.”