Changes to auditing standards over the past couple of decades appear to have been dominated by the idea of a one-size-fits-all approach based on the needs of large, multinational companies. Smaller practitioners in particular feel that the resulting international auditing standards (ISAs) have been designed from the top down, with the procedures and requirements becoming increasingly extensive and difficult to follow, not to mention expensive.
Where does this leave small companies? While the continual increase in the audit exemption threshold means they might not need to have a statutory audit, a good number of them would like to have some kind of independent check to lend credibility to their financial statements. If, as expected is possible in the UK, the audit exemption threshold rises to £10.2m to bring it in line with new UK GAAP for smaller companies, the question is whether it is right for companies of this size to potentially escape any kind of external scrutiny.
“While we don’t get too many routine errors in the data we get from our clients, the figures in the financial statements can change quite significantly from those we were given at the start of an assignment, whether we are performing a compilation, a review or an audit,” says Catherine Willshire, partner at Price Bailey. “If having a separate standard for small company audits enabled an independent check of their financial position, this would have to be good for markets overall in making sure these companies’ financial information was more reliable.”
The idea of having a separate stand-alone set of rules for small company audits has been mooted for some time. Now the debate has had a shot in the arm with publication by the Nordic Federation of Public Accountants (NRF) of a consultation on its proposed new standard of audits of smaller entities (SASE).
This standard uses the same core audit principles that are found in the ISAs, with the distinction being that it is ISA-compatible rather than ISA-compliant. However, the NRF is adamant that quality is not compromised.
“An audit performed according to the Nordic standard is an audit that enables the auditor to express an opinion with the same level of assurance as an audit performed in accordance with the ISAs,” it says.
“Most business around the world is small. The question is, how you develop trust and make sure there is confidence in them as, by their nature, they tend to have more risk associated with them”
The SASE moves away from the ISAs by stipulating more generic criteria for audit documentation while still insisting on “sufficient and appropriate” audit evidence. It pushes auditors to use their professional judgement in designing audit procedures rather than having to perform specific pre-designed tests – for instance, the auditor can decide whether they need to attend the stock count, and to evaluate the need for a management representation letter to support other types of audit evidence.
This makes sense to Robert Holland, managing partner at James Cowper Kreston. “In reality, about 90% of the audit issues we face with, say, a £2m turnover trading company, are stock valuation, a debate about collectability of debts, and revenue recognition if this falls outside the obvious categories. If you can document simply what you are doing and why without having to fill in endless checklists as the ISAs require, you can perform the fundamentals of an audit quite quickly and within a simpler framework,” explains Holland.
“The audit work we were doing in the late 1980s isn’t very different from the audit work we do now. The tests are the same but they take twice as long because of the extensive documentation process required of detailed judgements that aren’t terribly relevant in the context of a small company audit.”
It’s not just professional advisers who think smaller enterprises benefit from some kind of validation: a surprising number of small companies do too. Just over a quarter of respondents to an ICAEW survey of small businesses carried out in 2014 felt it would be better for the economy if businesses like theirs were required to have an audit. Nearly half of businesses with between 10 and 50 employees said they would have an audit even if this were not compulsory.
“There’s definitely a group of businesses that fall well below the current threshold that have audits, largely because they are ambitious for growth and know that having an audit will enhance their financial reputation,” says Clive Lewis, head of small and medium enterprises at ICAEW.
“When a company reaches a certain level, with turnover of more than £1m, then I think the benefits of the audit become quite clear. Until you hit that level the audit is a bit of an investment but one that is still worth making.”
However, the survey findings also showed that there is some confusion about the services professional firms perform for their clients. UK companies below the audit threshold can opt for anything from accounts preparation to assurance over certain aspects of the financial statements and on to a full ISA audit. But small businesses often don’t understand all the options that are available to them or the pros and cons of each, says Willshire.
“Part of me thinks if you give more choice to people and they can see it has the word ‘audit’, then that’s fine. But I don’t think they would necessarily understand what an audit would be under the proposed Nordic standard compared with an ISA audit, or whether they would care.”
While ICAEW supports the idea of having another tool in the audit and assurance service armoury, it points out that introducing a different audit standard would raise a big question around regulation. “Applying full ISAs can be expensive because of the level of documentation required, not only to justify what you have done but in some cases what you haven’t,” says Henry Irving, head of ICAEW’s Audit and Assurance Faculty.
“As revenue recognition may not always be a risk for all audits you should not have to explain why you have not tested it in accordance with the standards every time. The SASE offers a different approach and involves practitioners using their skill and judgement to arrive at their opinion. It’s unlikely you could have this kind of standard coming out and not affect audit inspection and regulation.”
And while some smaller practices would like to be able to provide a more cost-effective audit service for their clients, having another standard and different associated regulation would add to the costs and complexity of practitioners’ operations. In the recent past when firms were using three different sets of accounting standards they had to ensure their staff knew UK GAAP, the FRSSE and IFRS and make sure the appropriate standards were being applied. “If the ICAEW student training were on the full auditing standards, would we have to provide training internally for the small one?” asks Willshire. “That would mean we would bear the additional cost of trying to provide cheaper audits.”
However, Holland feels the proposed standard could help bring the focus back on to small businesses – to companies that often want the comfort of having an audit. “I think we approach audit the wrong way around. We need to start small and build up, overlaying a more complex structure for public interest areas. Where you have a process of endless checklists then you face death by checklist: it’s too easy not to rise above the detail and you run the risk of not seeing an overall problem. We need to get back to a process that says: this stuff is important while this other stuff is only interesting.”
Whatever decision the Nordic accountants take, their consultation has put the idea of a separate audit standard for small companies back on the international agenda, a result which Irving feels is valuable. “This is a global challenge. Most business around the world is small. The question is how you develop trust and make sure there is confidence in these small businesses as, by their nature, they tend to have more risk associated with them than larger companies with a longer track record. That’s why this is worth exploring at the IAASB level, despite the substantial challenges to having a non-unitary audit.”
And UK businesses could benefit from this being tackled at an international level, says Holland. “Smaller businesses are becoming increasingly international in nature. For instance, one of my clients is a £10m turnover group based in the UK that is trading out of three countries. We need a more broadly international view on this subject.”