SME Audit Market Study: What we've been hearing
Published: 15 April 2025
12 minute read
Join Kate O'Neill, Director of Stakeholder Engagement and Corporate Affairs, Mark Babington, Executive Director of Regulatory Standards, and Dhruve Shah, Deputy Director of Professional Body Supervision, as they run through some of the early themes and feedback from the FRC's SME audit market study.
Transcript
0:10
Hello there, and welcome to an FRC in Conversation podcast.
0:15
My name is Kate O'Neill.
0:17
I'm the Director of Stakeholder Engagement and Corporate Affairs at the FRC.
0:21
Today, I'm joined by Mark Babington, Executive Director of Regulatory Standards and Dhruve Shah, Deputy Director of Professional Body Supervision.
0:31
Welcome, Mark.
0:31
And Dhruve.
0:33
Thanks, Kate.
0:34
Thanks, Kate.
0:35
Great to have you both here because you and your teams have been absolutely at the heart of our SME.
0:42
I'm going to call it study, but it is a massive project looking into not just reminding people of the importance of SMEs in the UK, but also examining a number of issues, mainly obviously about audit and access to audit, but also on some of the reporting that SMEs have to undertake in order to explain not just their strategy, but the way in which they undertake their business.
1:07
So we launched a market study two months ago examining the audit of SMEs.
1:13
I mean, how we approach that Mark, because I guess some people may have thought, well, an audit's an audit, we have to have them if we want to access capital.
1:22
So how do we approach it?
1:24
But more importantly, maybe how has it been received?
1:27
Well, I think first of all, obviously it's it's an exploratory study and it's helping us really to better understand this sector and what its needs are.
1:35
And as you said, Kate, this is part of a broader campaign where we're developing materials and thinking about our approach to what is an important part of the economy.
1:46
And I think, you know, we've had really, really good engagement.
1:49
And I think that demonstrates that this is a really important topic at the moment, SMEs really important to our economy.
1:57
And there's a lot of stakeholders have been willing to share their views with us.
2:01
So looking not just at the SMEs themselves, but also the advisers they draw on, the auditors who audit them and the investors and lenders that they approach for capital.
2:12
And I guess this is really important because to a certain degree, and Dhruve, I think you'd accept this, the FRC focus maybe is better understood around the public interest entity audit, which are typically larger, more complex companies.
2:28
But I guess, Dhruve, there's a whole other bit of the market as well, mainly covered by the professional bodies like ICAW, who of course the FRC supervises.
2:40
But what do you think some of these initial observations from our engagement are and what are they telling us?
2:46
Because I think you're going to violently agree with this, Dhruve and probably Mark, The FRC is responsible for regulation of the whole audit market.
2:55
Yeah, Kate, you're right.
2:56
I do violently agree with that.
2:58
We are responsible.
2:59
So we're responsible for the whole market that ranges from the smallest owner managed businesses who might operate one or two High Street premises to the largest companies on the FTSE 100 Stock Exchange.
3:09
And the initial findings have been really interesting actually.
3:12
There's a really, really diverse marketplace.
3:14
That's our initial reflection.
3:16
There's thousands of audit firms ranging from 1:00 to 2:00 partner practises to much larger firms with a number of regional offices.
3:23
But it's worth noting, unlike the pilot audit sector, the largest audit firms do very little SME audit relative to the size of the market.
3:31
One of the most pleasing initial findings is SME owners and managers perceptions of the value of audit.
3:37
Certainly in the first couple of years they feel an audit can be really valuable in identifying which key controls might be improved to support their organisation governance.
3:44
And that emphasises just how important an audit can be in supporting SMEs to scale and grow.
3:50
I think that's a really important point because maybe some of our listeners don't always appreciate the important link between audit and access to capital.
4:00
In as much as providers of capital want assurance that the way in which the company is being run, its accounts, everything that they're talking about can be assured, you know, the audit can be signed off.
4:12
And you know, I guess if you're looking at the whole of the market, as you say, Dhruve, that's a big spectrum of size, approach, etcetera.
4:21
So this is where the FRC delegates this oversight of some of these smaller firms to the professional bodies, isn't that correct?
4:30
Yeah, that's right.
4:31
So the FRC directly supervises the public interest entities.
4:35
You mentioned the pie audits, but the vast majority of SMEs won't be pie audit.
4:40
So they're regulated by bodies like you said, the ICAW or the ACCA, ICAS or Charter to Canton's Island.
4:47
They're the four bodies responsible for regulating non π audits within the UK.
4:52
But it's my team's role to make sure that those bodies are appropriately regulating the market and they're delivering their FIC delegations appropriately.
5:01
So whilst we don't directly regulate SME audits, this is a really important study for my team to be involved in because it feels like a great chance to get customer feedback, one from the SMEs who are customers of the audits themselves, but also our audit practitioners who are the customers of the RSPS regulatory activities.
5:22
So I guess also there's a size issue here, and I'll bring you in as well here, Mark, because I guess, you know, you wouldn't be expecting for a smaller company, which let's be frank, the company's act definition doesn't mean a corner shop.
5:36
Some of these companies are actually very large.
5:39
But it wouldn't be appropriate, wouldn't Mark, for people to be auditing a smaller, less complex company in the same way you'd be auditing, I don't know, BT or Shell.
5:49
You're absolutely right, Kate.
5:51
The starting position for any audit is thinking about the risk of material misstatement of the accounts.
5:57
And effectively you design your audit to make sure that if there is a risk of material misstatement, you identify it.
6:04
But many of these businesses aren't complex.
6:07
They maybe operate from a single site, they don't have complex financial instruments.
6:12
And therefore, the audit approach that you follow can be a lot more proportionate and a lot more straightforward.
6:20
So both of you on this one, I guess, I mean, do you think there's a clearer understanding of not all audits are the same?
6:26
Perhaps SMEs see the value of audit, perhaps don't always understand what's the basis of a good audit, what are the parameters?
6:34
And I guess it's not the FRC saying audit this as though your BT or Shell, the audit firm itself has to scale, has to make this proportionate.
6:44
I mean, Dhruve, do you want to take that first then Mark?
6:47
Yeah, definitely.
6:48
Thanks, Kate.
6:49
You're right, the audit standards are inherently scalable and it's auditor's role to design the audit that's most appropriate for the body they're auditing.
6:58
And the feedback from SMEs is they're a little bit frustrated sometimes actually they feel they're smaller in scale, but audit firms are often employing what they feel their words to be box ticking exercises and they don't necessarily see the value in audit generates, certainly once they've had an audit for a few years.
7:17
And Mark, I mean, we know that some of the larger firms adopt global methodologies, but what's your message to the firms?
7:24
It's your team who set the UK auditing standards.
7:28
We've obviously got to take into account international auditing standards or else we would have Divergent.
7:36
The auditing standards are scalable, so you can use them to audit BT or you can use them to audit an owner managed business, and it's really important that auditors use the flexibility that are in those standards to scale their audits accordingly.
7:51
What we don't want is just one-size-fits-all.
7:54
Ultimately an audit is there to provide reasonable assurance that the accounts are true and fair.
8:00
But obviously you've got to think about how much work do you need to do and what tests do you need to do to give you that assurance.
8:08
It's not the fact that everything needs to be the same.
8:11
So this sounds like this is a super helpful, I don't want to diminish it, but a listening phase of this project to really hear from, as you say, such a wide range of the players in this phase.
8:24
So then we can come as the regulator to help audit firms and SMEs understand better how the tools can be deployed.
8:34
I mean, one of those things is to understand the factors driving SMEs to procure and audit.
8:40
Is it just regulatory compliance or are there other factors influencing SMEs audit decisions?
8:47
There are a number of factors that drive SMEs to secure an audit.
8:50
So the first is that regulatory compliance.
8:53
If you're a company of a certain size, there is a legal requirement to procure an audit.
8:57
But we've also heard SMEs seeking to procure audits because they want to access finance or because the owners of the organisation aren't involved in the day-to-day running of the organisation.
9:07
So they want that audit to provide assurance that the numbers are correct, true and fair.
9:13
In this case, we also see examples of governance documents for these SMEs which flag a requirement for an audit because there's a perception that a clean audit opinion is a good hygiene factor.
9:25
It shows that company is stable and reasonable investment.
9:28
Thank you Dhruve, but I guess Mark, people wanting all of those reasons that Dhruve’s just outlined as to why you would want an audit.
9:36
There is a difference between and I hate to introduce another acronym into the FRC world, LCE ‘A Less Complex Entity.
9:46
And why would you apply the ISAs which your team draw up in relation to standards in the same way to a less complex entity?
9:57
Well, there is a standard that the International Board has developed for less complex entity audits, but it's designed for very small and simple audits.
10:08
So many of the SME entities that we refer to would be too large and too complex to use that standard.
10:16
It also does have the same requirements as a set of ISAs.
10:20
They've just been bought together into a single form.
10:23
So it doesn't mean that you can short circuit the process and it doesn't mean you're doing half an audit.
10:30
You're still doing the same number of requirements. And I think Mark, because that has come up in a lot of the round tables, we're going to design a particular, I think it's going to be a webinar on this very specific point to kind of close the gaps of understanding.
10:45
Is that right?
10:47
Yes, Kate, I think, you know, what we found out from our engagement so far is lots of people have some very differing views.
10:53
And you know, one of the benefits of this exploratory phase of our work is it really helps us to design the rest of the project to make sure we can maximise its value.
11:03
And I guess the consultation that was undertaken in relation to this issue was in 2021.
11:08
So it's maybe timely to update people or at least remind them of what was the approach to this and why we've landed where we have.
11:17
I'm also mindful, Kate, that if you're thinking back to 2020 and 2021, we were working in some very strange circumstances at that time.
11:25
So probably a good opportunity for re-engagement.
11:28
No, that's absolutely right.
11:30
And when you think of this in relation to the work of FRC, and I probably overuse this analogy, this shows the crucial kind of, the three-legged stool.
11:40
When you've got well drawn up accounts, true and fair, saying the truth about the company's financial position, which is signed off by a board owner, founder, whatever the governance, where assurance can be provided, that creates this environment for stakeholder confidence.
11:57
And that's not just providers of capital, that's employees, that's supply chains.
12:02
So I think Dhruve, that's been a thread that's run through this that, you know, this is all part about creating trust and confidence in a business.
12:11
Yeah, that's absolutely the case, Kate.
12:12
And I mentioned previously, investors and stakeholders of SMEs do see an audit opinion as a good hygiene factor, but it's just one of that those 3 principles you outlined there and all of those collectively build trust and confidence in the economy. And is the place where growth is going to start.
12:32
I mean, Mark, I think I read a statistic it's 5.5 million SMEs operating in the private sector.
12:39
And you both have talked about the unique circumstances of each company.
12:44
It's not a one-size-fits-all, but the standards the FRC sets is only just one part of the reporting framework that apply to them.
12:52
I mean, I guess we can't be deemed to be responsible for everything in relation to how an SME reports or what it reports on.
13:01
No, absolutely.
13:02
There are things that we do in the audit space, in the reporting space, but you know, we are careful in that reporting space to try and make sure that we have reporting frameworks that are fit for purpose.
13:13
So if you're amongst the smallest of entities, you can use FRS 105 designed for micros.
13:19
If you're wanting to use a more comprehensive package, you've got FRS 102, but if you're part of a group structure, you can use a reduced disclosure framework.
13:29
So, you know, we've got flexibility that we can deploy.
13:33
However, there are a number of other legal and regulatory requirements that are set, and we need to make sure that in reporting and in auditing companies and their auditors are aware of those and deliver on them.
13:46
Yeah.
13:47
I mean, I know that we often talk about the stock of regulation, the stock of requirements.
13:52
And you know, I think this is an important opportunity to remind our listeners, it's got to be proportionate to the company's strategy, its size, its complexity.
14:02
And I guess some of these roundtables have really given us some food for thought on what are the priority areas where supporting materials, some of our Mythbusters, our one pages that we've developed already in relation to some of the perhaps myths about audit, that if we can put those to bed, we can, I guess, help enable people to understand the importance of audit better.
14:25
Absolutely.
14:26
And you know, one of the things about an audit is if you are the person who's commissioning the audit, if you've invited someone to come in and do the audit, are you equipped with being able to challenge and ask the right questions about whether or not you're getting the job you need?
14:41
And I guess Dhruve from that point, the professional bodies are an important tool in this better understanding of how auditors are explaining the audit to these smaller and medium sized companies.
14:53
Yeah, definitely, Kate.
14:54
So I just want to flag here my thanks to all the professional bodies we've worked with so far.
14:59
They have that day-to-day engagement with the bulk of SME auditors.
15:02
They also have amazing networks when it comes to SME entities themselves.
15:07
So we'll be relying on the professional bodies, and we'll work collaboratively with the professional bodies to prepare the best possible material to serve this important stakeholder group.
15:16
And so just wrapping up on this great reminder of where we've got to in this project.
15:22
And it's a great milestone because the invitation to comments finishes on the 25th of April.
15:27
So what's next?
15:28
I mean, what do we want to do with the market study?
15:31
Do we want more responses?
15:33
What's going to be most helpful, because that's only a few weeks away and I think Mark, maybe you'd like to outline the practise note and interim findings, which I guess we're looking to put out later in the spring.
15:45
That's right, Kate.
15:46
And you know, the practice note will be something that will help people scale audits better to meet the needs of SME entities.
15:54
One of the things we will be doing is putting that out for stakeholder comment.
15:58
So that will be an opportunity to engage and really help us refine the product.
16:03
But also, we're thinking about what are the steps that we can take to make sure that the SME audit market is working really well for this important sector of the economy and there'll be more engagement, and we will develop our full toolkit to help with that.
16:18
As we mentioned earlier, we'll plan a bit of a reminder on that 2020-2021 consultation on Lcas and bring people perhaps up to date and in some cases, maybe remind them of how we've taken the approach we have.
16:32
So look out for that webinar in the next few weeks when we advertise it.
16:38
Dhruve, do you feel encouraged?
16:39
Do you think these round tables have given you the information that you think you and the professional body supervision team, but the wider FRC can use to really encourage a better understanding of what SMEs need in the audit sector?
16:55
Yeah, definitely, Kate.
16:56
I've been incredibly encouraged.
16:58
I mean, one of my reflections from these round tables is a lot of the challenges SME auditors face are also faced by auditors of larger entities.
17:05
You know, concerns about the future pipeline auditors or audit not being as attractive a profession as it used to be.
17:11
The fear of regulatory activity by the FRC or the RSBs driving auditors to do more, not less.
17:17
And I just wanted to flag here, we're really keen to hear this feedback.
17:21
So even if the feedback isn't directly able to be actioned through Mark and his team's practice note, we will be reading every single bit of feedback and we'll be reflecting on how this feedback might be fed into some of the wider change programmes currently underway at the FRC, specifically the Future of audit supervision strategy.
17:39
And Kate, if I may be cheeky and just add a second point.
17:42
You asked if I was encouraged by the round tables.
17:45
I think I'm, I've also felt a sense of pride at these round tables.
17:48
I was an auditor 15 years and I've always been really proud of being an auditor and engaging with these round tables has reignited that pride actually, because every single individual we've engaged with on the audit side has been really committed to securing the best for the future of the profession.
18:03
And that's a real privilege to be a part of the regulatory space of such an amazing profession.
18:08
Thanks, Dhruve.
18:09
I mean, Mark, maybe you've got a couple more years on Dhruve in the audit space.
18:13
But I mean, do you think that what we're hearing through these round tables encourages you and particularly the standards team of the important work they do in making this trust and confidence such a bedrock of the SME community?
18:27
Yeah.
18:27
I think what I take away from it, Kate, is that people have been very clear that they really value an audit.
18:34
And an audit that's done well can bring huge benefits to an SME business.
18:40
And it might be because it helps them attract investment or it encourages access to finance and investment, which is really positive.
18:48
It can help them grow.
18:50
I think for larger businesses, it may also be really helpful in them approaching listing on the exchange.
18:57
And for the really small businesses that have an audit, it might bring comfort to the business owner that they know what their assets and liabilities are and that they've confirmed that their tax position with HMRC ties in with their accounts.
19:10
So there's a lot of benefits from there.
19:13
And auditors can also help through their recommendations, make a company work more effectively.
19:19
Well, thank you both.
19:20
And I really got a sense of, as Dhruve says, the pride, but in the profession, but also the importance of audit to supporting SMEs grow, thrive and scale.
19:30
Thank you both and look forward to all of our listeners who are involved in this process continuing to give us their support in the planned activities throughout the spring.
19:40
Thank you very much.
19:41
Thanks, Kate.
19:42
Thanks, Kate.