ICAEW has welcomed the Financial Reporting Council’s (FRC) four steps aimed at tackling issues in the SME audit market, following a year-long study.

The study highlighted a range of concerns among SMEs, auditors of SMEs, and recognised supervisory bodies (RSBs) about the market for SME audits, the auditing standards governing them and how they are performed in practice. The study highlighted five issues to be addressed for SME audits:

1. A widespread perception of lack of scalability of auditing standards, as well as issues with ethical standards.
2. The existing supervisory framework, which needs to encourage more proportionate approach to SME audits.
3. Issues with the use of emerging technologies in SME audits.
4. Variations in knowledge and understanding of audit among SMEs themselves.
5. Issues with the value of audit for SMEs.

The lack of scalability in particular was highlighted as an issue for practitioners and SMEs. Almost one-third (29%) of SMEs surveyed wanted audits to be quicker and more efficient, and 52% felt that financial audit requirements resulted in excessive costs for their organisations.

Practice Note 28

The main plank of the FRC’s response to the market study is the introduction of the new Practice Note 28 on how to apply ISAs to an SME audit. This follows the withdrawal in 2019 of Practice Note 26, which dealt with audit documentation for SME audits. 

The FRC took feedback on its proposed Practice Note 28 during the back half of last year. Respondents, including ICAEW, requested further clarity on the scope of the guidance and on how the standards would be practically applied. Feedback also included questions about the effectiveness of guidance in fully addressing the issues raised in the market study.

The scope of Practice Note 28 is wider than that of Practice Note 26 and includes more examples of the practical application of standards. It now includes sections on:

• planning an audit and materiality (primarily covering ISAs 300 and 320),
• risk identification and assessment (ISA 315),
• risk responses (ISAs 500 and 520), and
• group audit (ISA 600).

Going concern (ISA 570) and fraud (ISA 240) are also covered.

Other measures

The FRC plans guidance on the application of the ethical standard and options under the provisions available for audits of small entities (PAASE) will follow, to “enhance better understanding of the standard among SME auditors and encourage greater utilisation of these options”.

The FRC also plans to establish a working group to identify and implement changes to SME audit supervision and communicate the value of audit to SMEs. Technology constraints will be addressed through a technology sandbox, which will facilitate discussions on the topic.

Nick Reynolds, ICAEW Professional Standards Head of Audit, welcomed the FRC’s focus on the audit market for SMEs.

“These findings highlight the important role that many smaller audit firms in the UK play in supporting the great majority of the private and entrepreneurial businesses in this sector that underpins the UK economy,” he said.

ICAEW, as an RSB, will engage with the FRC on proportionate and risk-based audit monitoring, he added.

A call for views on the ISA for LCEs

Many respondents to the FRC’s consultations that preceded the issue of the final report, including ICAEW, called for discussions on how the ISA for LCEs (less complex entities), issued by the IAASB might be made fit for purpose in the UK.

ICAEW has therefore welcomed the FRC’s undertaking to launch a call for views on the ISA for LCEs, as well as a sandbox on scaling the ISAs.

Katharine Bagshaw, ICAEW’s Senior Manager, Auditing Standards, Audit and Assurance, said: “We are delighted that as well as issuing Practice Note 28 and the sandbox, the FRC has decided to launch a call for views on the ISA for LCE in the near future.

"The standard is far from perfect, but this is a very promising first step to help practitioners and the FRC better understand what changes might be needed to make it fit for purpose in the UK, and which entities it might apply to.”