SME Audits: Challenges and Insights

John Hodge, Kalina Shukarova Savovska | June 22, 2016 | 1

For a few years now, deregulation of mandatory assurance of SMEs has been on the rise, while at the same time, so too has the regulation of audits of larger entities (i.e., public interest entities). This deregulation for SME audits is largely caused by governments raising audit thresholds and requiring fewer audits to be performed by law in response to calls to reduce the regulatory burden for small businesses. Although regulatory demand for audit services is decreasing, demand for voluntary audits continues.

Accounting practices operating in the SME audit market face significant challenges, but it is important that they achieve sustainable financial results with audit service revenues that exceed the full cost of delivering high-quality audit services. Cost cutting that is directly reflected in the quality of the services performed is not a sustainable approach.

Given the importance of these challenges for practitioners, small- and medium-sized practices (SMPs), and professional accountancy organizations (PAOs) supporting their members, an Audit Training of Trainers (Audit ToT) Community,[1] under the EU REPARIS Program,[2] facilitated by the World Bank Center for Financial Reporting Reform (CFRR), exchanged ideas on this topic, as well as discussed some related insights which can be useful for practitioners when engaging with SME audits. The Audit ToT is a training program with a practical focus that develops the capacity of audit trainers to deliver high-quality training and Continuing Professional Development (CPD) programs, with particular focus on meeting the needs and challenges of SMPs in implementing ISA—International Standards on Auditing.

These discussions have been summarized and published in a CFRR-related publication Smaller Audits: Challenges and Insights. Some of the key messages are:

* The auditor of a small business is required to be as proficient in all relevant standards as the auditor of a large, publically listed entity. From an SMP perspective, keeping up with changing requirements and maintaining the required knowledge base can be challenging. However, having complete knowledge of relevant auditing standards, coupled with experience in making good professional judgments, is essential for SME audit efficiency. Performing excessive audit work is an avoidable cost and so too is the consequence of not performing enough work. 

The good news is that ISA can be applied proportionally to SME audits. ISA are principles based, allowing practitioners to apply professional judgment and tailor audit procedures. Some ISA only apply to larger entities and the requirements of the auditing standards can be scaled down in order to be more proportional for SME audits.

* Simpler businesses do not necessarily mean an easier audit. Small businesses tend to have particular characteristics that require increased attention, for example, fewer financial controls, more related-party transactions, lower capacity to close the books (i.e., accuracy of accruals and provisions), and can be subject to some complex taxation requirements.

Having fewer, more experienced professionals involved in the audit can bring many benefits and efficiencies to the audit process. More experienced audit professionals often make quick and effective professional judgments, have particular industry/sector specialist knowledge to allow a tailored approached, and are proficient at using audit technology to automate the audit process. More experienced auditors often have an in-depth understanding of the standards which allows them to work quickly and effectively, performing the right amount of work and avoiding over documentation.

* The downward pressure on SME audit fees is largely due to the market viewing the audit opinion as highly standardized. On the other hand, the audit process is labor intensive and auditors are subject to initial and continuing education requirements, so the challenge for many auditors is how they can grow audit revenues while maintaining audit quality.

Smaller clients are ready to pay for audits that they perceive add value. Also, small businesses are willing to pay their auditors for good business advice. By learning how to operate with a “trusted business advisor” practice model, auditors can learn how to bill their clients for the value of their advice, over and above the audit.

* Governments increasingly, have no legal requirement for the audit of general purpose financial statements of “micro” and “small” businesses because such regulatory obligation is not seen to add value to the small business owner, nor does it foster small business growth. This lower regulatory burden is generally well received by the business world as it minimizes compliance costs, but it also “shrinks” the size of the market for auditors of smaller businesses.

Responding to the rising audit thresholds, many audit practices have started to expand their service offerings and have engaged in a process of changing their practice models. Business advice and other structured non-assurance services (i.e., agreed-upon procedures, compilations, etc.) can provide small business stakeholders with some confidence even where no audit or review opinion is provided.

The IAASB recently revised its standards on review and compilation engagements, and there may be increased demand for the performance of review engagements arising from governments looking for a regulatory response that is perceived to be proportionate to small entities. (SMPs can find guidance from IFAC on implementing the IAASB’s revised review and compilation engagement standards on its website.)

* Evolving markets and new services will require practitioners to make significant investments in skills and technology, as well as to move away from the traditional practice model and develop new ways of operating. This innovation is essential to maintaining profitability in light of fee pressure on SME audits and the need to provide other value-added services in order to grow revenue.

Some practitioners may choose to specialize in non-audit services and move away from audit services. In other cases, market consolidation may help smaller audit practices to achieve scale. Mergers of audit practices operating at the smaller end of the market may become increasingly common. In order to attract talent into the profession, it will be important that audit practices are profitable.


[1] Including trainers from Albania, Kosovo, Bosnia and Herzegovina, Bulgaria, Croatia, Estonia, Romania, Montenegro, Macedonia, and Serbia.

[2] The Road to Europe: Program of Accounting Reform and Institutional Strengthening.

 

John Hodge

Senior Financial Management Specialist, Centre for Financial Reporting Reform (CFRR), The World Bank

John Hodge is a Senior Financial Management Specialist, with the Centre for Financial Reporting Reform (CFRR), The World Bank. He supports activities to strengthen the accounting profession and provides policy advice on corporate financial reporting reform. Prior to the CFRR, he was a General Manager with Chartered Accountants Australia and New Zealand and was with PwC specializing in assurance in New Zealand, Canada, and Italy for over 13 years.

Kalina Shukarova Savovska

Principal, International Auditing and Assurance Standards Board (IAASB)

Kalina Shukarova Savovska is a Principal of the IAASB. She is currently working on several IAASB projects, including the Auditor Reporting Post-Implementation Review, Audits of Less Complex Entities and the Complexity, Understandability, Scalability and Proportionality project. She had previously worked as Senior Financial Management Specialist, with the Centre for Financial Reporting Reform (CFRR), The World Bank, supporting activities involving accounting education and capacity building, providing policy advice on corporate financial reporting reform and the development of the accounting and auditing profession, with a primary focus on auditing standards. Before, Kalina was also an Executive Director with Ernst and Young specializing in assurance. See more by Kalina Shukarova Savovska

 

Explore More On...

 

Join the Conversation (1)

To leave a comment below, login or register with IFAC.org

 

Ricardo Rodil June 29, 2016

Dear Kalina, John and readers, Allow me to add some pepper to the discussion. In general, I agree with your views but would like to contribute with some thoughts. * Simpler businesses do not necessarily mean easier audits. Great!! Chances of having owners/managers overriding controls are usually higher at SMEs. That means that the proportion of substantivbe procedures increases and has an obvious effect on fees, what narrows the market, and so on, and so on. * I've never been very comfortable with the auditor os SMEs being seen as a 'trusted business advisor' for it can jeopardize independence. We have toi be extremely careful and try to act as 'conveyers' of facts and opportunities and as eye openers, but making it sure that final decision lays on Management hands. * Reviews, compilation, agreed-upon and the like are good alternatives, but they depend on the business environment. For example, in Brazil, they have a very restrict use for the SME community is not aware of the benefits. On the side of good news, I celebrate your phrase 'demand for voluntary audits continues'. Additionally, I think that we professional accountants have to 'educate' the market in this sense. Last but not at all least, congratulations on your article. Ricardo Julio Rodil Audit Partner BDO Brazil

 

Thank you for your interest in our publications. These valuable works are the product of substantial time, effort and resources, which you acknowledge by accepting the following terms of use. You may not reproduce, store, transmit in any form or by any means, with the exception of non-commercial use (e.g., professional and personal reference and research work), translate, modify or create derivative works or adaptations based on such publications, or any part thereof, without the prior written permission of IFAC.

Our reproduction and translation policies, as well as our online permission request and inquiry system, are accessible on the Permissions Information web page.

For additional information, please read our website Terms of Use. ALL RIGHTS RESERVED.

Agree