Challenges and Insights of Small- and Medium-Sized Entity Audits

In June 2016 the International Federation of Accountants (IFAC) issued its IFAC Global SMP Survey 2015 conducted in countries with professional institutes that are members of the Federation of European Accountants (FEE). The report provided an insight into the key trends and developments facing small- and medium-sized practitioners (SMPs) and their small business clients.

The survey identified that the four most pressing challenges to SMPs were: keeping up with new regulations and standards (55%), attracting new clients (48%), differentiating from competition (43%), and keeping up with new technology (41%). Other challenges were also mentioned such as experiencing pressure to lower fees, managing cash flow and late payments, and retaining existing clients.

Audits of small- and medium-sized entities (SMEs) are a special class of client, with a unique set of challenges that the practitioner needs to address when servicing such smaller clients. This article draws upon the key points mentioned in a Centre for Financial Reporting Reform (CFRR)-related publication titled Smaller Audits: Challenges and Insights, which highlights some of the challenges mentioned in the IFAC Global SMP Survey and others. It also provides useful insights for SMPs.

ISA 200 ‘Overall Objective of the Independent Auditor and the Conduct of an Audit in Accordance with International Standards on Auditing’, identifies a “smaller entity” as typically possessing a number of qualitative characteristics. These include the concentration of ownership in a small number of individuals and one or more of the following, among others:

  1. Straightforward or uncomplicated transactions;
  2. Simple record-keeping;
  3. Few lines of business and few products within business lines;
  4. Few internal controls;
  5. Few levels of management with responsibility for a broad range of controls; or
  6. Few personnel, many having a wide range of duties.

The above characteristics clearly indicate that the risk profile of a smaller client and therefore the skills required to audit the companies in question are particular, or in other words ‘a specialty’. If one had to compare the small audit to the audit of a larger public company, the risk profile of the latter in terms of public interest is higher. However, one should also consider that larger companies have certain structures to mitigate this risk such as an effective internal control system in place. In contrast, smaller audits are very often characterised by an owner-manager, with the risk of management override of controls.

On the other hand, the skills that an auditor requires are equally onerous. The auditor likewise has to apply professional judgment in performing the audit of SMEs, requiring an in-depth knowledge of auditing standards and possessing a broad set of skills such as sufficient knowledge of tax, law and other areas.

The following details some of these challenges and the way that they can be addressed:

  • Challenge: SMPs are required to be equally proficient in all relevant standards. New and revised standards, including conforming amendments to other ISAs, need to be understood and applied. This can be particularly challenging for sole practitioners and SMPs. However, knowledge of all the standards is essential in order to apply professional judgement and determine which of the standards is applicable.
  • Insight: The good news is that ISAs are principle-based and do not include specific audit procedures. They allow professional judgement to be applied and proportionate application in the case of smaller audits. Some ISAs include sections with specific reference to smaller entities entitled ‘Considerations specific to Smaller Entities’. Additionally, a number of publications, such as those issued by the IFAC SMP Committee and International Auditing and Assurance Standards Board (IAASB), are a valid source of information.
  • Challenge: Although small companies are less complicated in terms of transactions, IT environment, and ownership, they still have their complexities. Very often they have few financial controls, more related party transactions, possibly complex taxation requirements and their closing entries are not accurate or complete. Therefore, the auditor needs to have a good knowledge of the business, financial reporting standards, other laws and regulations as well as auditing standards, if the audit is to be performed in an efficient manner.
  • Insight: Efficiency is key to address this risk. Auditors should have an in-depth knowledge of the ISAs to ensure that the right amount of work is performed and allocating fewer experienced professionals on the job will ensure that better professional judgment is applied on the particular job. Specialisation by industry/sector helps the practitioner develop tailored approaches, which can be applied to a number of engagements. Finally, the use of technology in the audit process increases efficiency, facilitates procedures and access to documentation and evidence.
  • Challenge: Audit fees are continuously facing a downward pressure, largely stemming from the fact that the final product – the auditor’s report – is highly standardised. On the other hand, ongoing compliance with the requisite standards, continuing education requirements and the fact that very often the audit process is labour intensive puts further pressure on the profitability/viability faced by SMPs.
  • Insight: A quality audit is always expected regardless of the fees. Auditors should therefore do their utmost to exploit their expertise. Audits should be performed as efficiently as possible, reducing the amount of ‘unbilled’ work. This could be further supplemented by giving more value added such as a detailed management letter, which provides insights into weaknesses in the internal control with related recommendations for improvement. Furthermore, as long as the significance of the threat is evaluated and adequate safeguards are in place, auditors could provide business advice and mentorship, supporting SMEs in their growth strategies and access to finance. The latter would enable the auditor to bill their clients for the advice given, over and above the audit.
  • Challenge: The new Accounting Directive raised the audit exemption thresholds. In many EU countries this change decreased the requirement for the audit of general-purpose financial statements of “micro” and “small” entities. This did not bring about any change in Malta where a statutory audit is required for all entities 1. However, in the local scenario the market for small audits is limited, and competition is therefore greater, thereby increasing the pressure on SMPs.
  • Insight: Audit practices are encouraged to expand the services and offer other assurance or non-assurance services, such as agreed-upon procedures and compilations. As outlined in a recent guidance issued by MIA (AUDIT 02/16 – Verification of financial and non-financial information other than the statutory audit of annual financial information), addressing these situations, auditors are increasing required to offer various forms of assurance, for the verification of financial or non-financial information, other than the statutory audit of annual financial information, by different parties including tax authorities, regulators and banks. Practitioners should however refrain from simply signing a one or two sentence “certification” and should always refer to the IAASB framework to identify the applicable standard and therefore the most appropriate form of reporting, including any revised applicable standards.
  • Challenge: Auditors work in an environment of SMEs operating in evolving markets and new services. Auditors are expected to have the skills and judgment required to perform these audits. Auditors should also be further supplemented with necessary IT investment to enable them to perform the audit efficiently and methodologically. However this requires investment in resources and IT, which puts further strain on SMPs when coupled with the downward pressure on audit fees or clients, which are so small that the economic benefits can never be maximised.
  • Insight: Auditors can address this challenge by adapting, innovating and finding new ways to manage and operate their practices in various degrees and forms. This includes investment in technology with customisation, on a larger scale merging of audit practices, and/or developing new ways of operating.

Auditors of SMEs need to deliver value to their clients while maintaining quality and complying with the applicable standards. This can sometimes be challenging but there are key aspects of the audit, which, if managed well, can still be profitable to the SMP. This requires investment of time in both quality control and practice tools that simplify the mechanics of the audit process.


  • 1 A statutory audit is not required for companies falling within the thresholds set by Art. 185(2) of the Companies Act. However it is still required for income tax purposes.
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