Understanding audit standards
Published: 19 March 2025
10 minute read
As part of the FRC's campaign to support SMEs to engage with and access audit, Kate O'Neill, Director of Stakeholder Engagement and Corporate Affairs, and Mark Babington, Executive Director of Regulatory Standards, discuss the role of audit standards and how they can be applied in a proportionate and scalable way.
You can also listen on Apple Podcasts and Spotify.
Transcript
0:10
Hello there, and welcome to an FRC in Conversation podcast.
0:15
My name is Kate O'Neill.
0:16
I'm the Director of Stakeholder Engagement and Corporate Affairs at the FRC.
0:20
And today we're joined by our Executive Director of Regulatory Standards, Mark Babington.
0:26
Welcome, Mark.
0:28
Thank you, Kate.
0:28
Good to join you.
0:30
And today our topic is really the first of our series of a myth busting podcast, which we referenced Mark, when we launched the very, very important SME campaign a few weeks ago.
0:44
Because we really want people to better understand some of the FRC's remit in this area and maybe debunk some of the myths about how things like audit standards are applied and our reporting requirements as well.
1:00
Absolutely, Kate.
1:01
And there's a lot of noise sometimes out there where people think they understand what we're responsible for and what we're not and what we do.
1:09
And this is a really good way of trying to clarify some of those questions.
1:13
We talked in other podcasts then, but I won't assume everyone listening has heard those.
1:19
I think what people have to better understand as well, Mark, the FRC is responsible for the whole market, obviously the pie market, which is usually undertaken by larger audit firms, but also for smaller audit firms who are in the first instance supervised by the professional bodies but ultimately overseen by us.
1:39
But an SME, like all companies, it's not one-size-fits-all, right.
1:44
I mean the complexity of the business, the size, what it does, who its stakeholders are vary greatly across the SME spectrum.
1:53
Oh, absolutely.
1:53
Kate.
1:54
You think about it.
1:55
In the UK we've got big financial services institutions where the audits delivered by a team of thousands of people working in multiple jurisdictions.
2:06
In an SME situation, it will be a much, much smaller team, maybe two or three people or maybe even an individual practitioner.
2:14
However, they are using the same standards and it's important that they use them in a way where they scale them and ensure that the work they're doing is appropriate to the level of risk and the level of complexity of the entity that they're auditing.
2:29
All audits marks start with auditing standards.
2:32
So today it would be great to help some of our listeners understand this better.
2:38
When we talk about these standards, we're referring to international auditing standards, commonly known as ISA's.
2:45
What are they?
2:47
So that's right, Kate.
2:48
So they're a set of globally recognised standards.
2:51
They're set at the international level, they're principles based and they provide guidance in their application, guidance on how to use them, how to scale them for different sizes and different complexities of audit.
3:05
And they're used in more than 130 countries globally.
3:09
So an audit that someone does in the UK will be very similar to the audit that somebody's doing in Australia, South Africa or lots of other jurisdictions.
3:20
I want to put a pin on in that and come back.
3:22
So I think that's such an important part of the understanding of why this ability to compare financial results is so important.
3:31
I mean, I really liked what you said about scalability and I guess, and I know this, you do get frustrated where people perhaps without better understanding think, well, the standard has to be applied in exactly the same way to every single company.
3:49
Do you say to people who challenge you with that?
3:52
Well, I'm not a supporter of that, Kate, for for the very simple reason that all of these companies are very different.
3:59
We're not actually comparing the same entity and the same entity.
4:02
And these entities will have different risks because of the activities they undertake.
4:08
They'll be of different sizes.
4:10
They may work in different jurisdictions.
4:13
And so one size doesn't fit all.
4:15
And that's why the standards that we have, auditors can tailor them to reflect the particular circumstances of the body that they are auditing.
4:24
But ISA's as the kind of starting point for audit are designed to give all stakeholders, not just investors or capital providers, because let's face it, capital is provided by lots of different people, whether it's a bank loan, whether it's public market investment.
4:42
It's about giving confidence so that you can compare the way in which audits are done on all different entities to your point of not one-size-fits-all, but also to give confidence that the accounts that have been audited have been prepared in the correct way.
5:00
Absolutely, Kate.
5:01
And you know, the things that we focus on when we're looking at an audit is the auditor gives their opinion to say, do these accounts give a true and fair view?
5:10
So, you know, is this an accurate representation of the company's financial affairs and have the accounts been properly prepared in accordance with legal and regulatory requirements?
5:21
So the auditor is providing a significant degree of confidence to the users of those financial statements.
5:28
And as you say, that could be an investor, however, it could be a bank issuing a loan, it could be another provider of finance, or it could be other people who have interest in a company, maybe because it provides local employment or it's a critical supplier to them.
5:44
And that's what we want people to be able to do is trust the information because they know it's been assured in a consistent way.
5:51
We want SMEs to scale up.
5:53
We want them to be getting the right type of assurance on how they can, as you say, maybe supply services be supplied to and comparable audits and comparable financial statements have to help in that way.
6:09
No, Absolutely, Kate.
6:10
And equally, you know, what we said about standards being used globally is that you're comparing things but you know that the same threshold, the same bar applies.
6:21
And that's an important thing because people deal with lots of different companies, lots of different sets of financial information and it's being able to realise that they have had the same level of assurance applied to it.
6:34
What do the Ices in the UK apply to?
6:37
All audits?
6:38
To all audits, Kate, Although in the context of the UK, there are around 80,000 statutory audits done under the Companies Act.
6:48
A lot of companies in the UK aren't required by law to have an audit, but they choose to have an audit either because they need to as a condition for accessing finance, be it from a bank or another provider, or it could be that their own articles of association or membership requirements say they have an audit.
7:08
So from that small core, there are probably more than three million additional audits that are done on a voluntary basis.
7:15
But there's only one set of standards, the ISA's, and therefore they're used from the very large and the very complex down to small and straightforward audits.
7:27
I mean, the word methodology comes up and audit firms in some cases do operate internationally.
7:34
If they have a firm methodology in the way in which they audit.
7:38
It's got to be based on the ISA's, right?
7:40
Yeah, absolutely.
7:41
You're meeting the requirements in the ISA's.
7:45
The Isas are developed not just, as you said, in one country.
7:48
They reflect an International Association.
7:51
What do you think that gives the kind of basis of an ISA?
7:55
Is that to get a good sense of whether they can work internationally?
7:59
Is it to reflect lots of different stakeholders?
8:02
Absolutely, Kate.
8:03
So the board that sets ISA's globally has 16 members and they're drawn from countries all over the world.
8:11
So the UK is represented on the IAASB, but there are people from sophisticated capital markets but also from developing nations.
8:22
And the reason for having that breadth of membership is to ensure that when standards are being set, the views of different types of economy and different types of business are all represented in those discussions to ensure that the end product will work regardless of where in the world you use it.
8:42
To an SME listening to this or an auditor who undertakes work for SM as would you be thinking, well, this is part of a vast machine that doesn't make sense to me given my size or complexity.
8:54
But you're saying if people are scaling the ISA's appropriately, applying the methodology properly, being part of this international standard shouldn't feel overly burdensome.
9:04
It should reflect your circumstances.
9:07
That's absolutely spot on, Kate.
9:09
And really what an audit is about is, are you getting sufficient appropriate audit evidence to support the conclusions that you draw?
9:18
And that's what we're asking for, sufficient, appropriate audit evidence, not twice that or three times.
9:24
That is consider the evidence that you need, carry out the work to find that evidence and then draw your conclusions.
9:31
And I think what we hear quite a lot is a concern that people are doing too much work to find that evidence, whereas the ISA's have flexibility and scalability, which means that you do enough and not more.
9:46
Yeah, On that, we may have some listeners who say, well, how do I know that my audit firm is applying these ISA's on a scalable and proportionate way?
9:55
I'm not an expert.
9:56
I don't know whether they're doing that.
9:58
And for some firms, they may struggle with how to articulate how they're applying them.
10:03
I mean, what's the FRC's role in this?
10:05
We can't, I guess, spoon feed people and oversee every single audit in the land.
10:11
No, we can't do that.
10:12
Indeed, we work with the professional bodies because they are doing the oversight of many of these audits.
10:17
But as you said Kate, we are doing a significant amount of work this year to shine a light on these SME audits and to make sure they properly serve the market.
10:27
And one of the things that we'll be doing as as part of that project is looking at developing guidance which will help with the application of requirements to smaller and medium sized enterprises and also help the directors of those companies ask questions of their auditors to make sure that the work that they say they're doing is really needed.
10:47
And also, I guess that's important, Mark, because some of the end users in the SME market would feel quite distant from some of the consultations that are done by IAASB and in some cases some of the standard setters like the FRC.
11:02
So this guidance note may bring to light for some firms and the end users some really important information that helps that relationship between a company and its auditor be perhaps more mature.
11:16
Yeah, absolutely.
11:17
And you know, when you have an audit, you're doing it for an important purpose.
11:22
It might be to meet a legal obligation.
11:24
It might be to help you access investment in your business, but it's important that you are involved in the design of that audit and you are discussing the design of that audit to make sure it's going to be fit for purpose for your business.
11:40
And you can do that through some simple questions.
11:43
And you know, we're going to be working with the sector to make sure that we put material in place to support that.
11:50
I guess a lot of people don't understand, and I don't want to frustrate you here, Mark, that not only are they principles based, the Ices, the auditing model they want to be used is risk based.
12:02
So they're very significant opportunities for conversations about scalability and proportionality, aren't they?
12:10
Absolutely.
12:11
And you've just actually identified a really good example there, Kate.
12:14
Ask your auditor what risks they've assessed your business as having.
12:18
Do they actually read across to you?
12:20
Do you think they make sense?
12:22
Do you think they're a realistic and proportionate assessment of the risks that you face?
12:27
And I think that's a really good dialogue to have.
12:30
But also with the ISA's , I mean, many people might think they're very, you know, set in stone.
12:34
They can't be changed.
12:35
I think during the pandemic, it was really interesting to see how the FRC and others around the world address some of the challenges that companies were facing on things like explaining going concern in a completely unpredictable market in a period that had never been experienced in any form before.
12:56
And, you know, I think we were very proud, weren't we, of the FRC's approach and pro-activity in helping both auditors and companies address what was a very challenging issue.
13:08
Yeah, that's absolutely right.
13:10
And it was about making sure that auditors use the flexibility that the standards give them and that they weren't being prescriptive.
13:19
So, you know, we've, we've said this often before, Kate, one of the most important things, one of the most important skills an auditor has is the application of their judgement.
13:29
And in a nicer audit, you apply your judgement to help you design how you get the assurance you need and also to think about, you know, the issues, the risks that you're wanting to address.
13:41
And I really hate it when people talk about audit as a process, because it's not a process.
13:46
The value of an audit is in the judgement that's being exercised.
13:51
I think that's something out of this project.
13:54
I would guess you and other colleagues, not just in the audit and assurance standards part of the FRC, but across the FRC in our supervisory activities and all of our engagement with not just the audit firms, but where we can help SMEs, the companies themselves.
14:10
But this isn't the only podcast we're going to do about publications supporting stakeholders in the firms.
14:16
What else do we have planned?
14:18
Well, I was going to say this all comes together as a wider package of work.
14:22
So we've already announced, for instance, the work that we're doing with a market study to better understand what this market needs and how it's sourcing that.
14:31
We've talked about the guidance that we're going to develop and to ensure that audits can be delivered in a proportionate way.
14:38
And of course, whilst this is ongoing, we still engage in international standard setting to make sure that the Ices that are set at the international level can meet the needs of a small and straight forward audit as well as they can meet the needs of a global bank.
14:52
And that continues to be a really important thing for us.
14:56
I think that's a great illustration of how wide-ranging this package is that we're trying to help a very important part of the UK economy understand and their advisers engage with them in a way that's potentially more helpful and more dynamic.
15:11
Now this week we start with our stakeholder round tables and we're really pleased with the sign up that we've been getting on that.
15:18
But I guess, like me, you'd urge people to get involved even if it's just to understand a bit better about audit reporting and what are the expectations of the SME market.
15:29
Yeah, absolutely, Kate.
15:31
And as you started off by saying, an audit can be critical for a business in accessing investment and finance.
15:38
And that's really important to all businesses.
15:41
And therefore, engaging in this process, asking questions and really importantly giving us your views is going to help us to ensure that we meet all of our objectives before we close.
15:53
I guess it's just to remind some of our listeners that we will be publishing on our website some guidance on not just explaining auditing standards and busting what we know to be some myths out there about what they are and how they're applied.
16:06
They're giving the business owners in the SME community those tools you mentioned to engage in the audit process with more confidence, but also more understanding of actually what audit is for.
16:18
Yeah, absolutely.
16:19
And that's going to be a really critical thing for us over the next few months as we roll out this project.
16:25
We really want to hear your views, Mark, for the first of our SME Project podcast.
16:31
I do think you've really opened up to so many of our listeners some of the realities about the ISA's, and some people maybe didn't even know they were called that, but also about why proportionality and scalability has always been at the core of the ISA.
16:47
So let's hope more people understand that, Mark, and there's less misunderstanding about what they're there for and what they demand.
16:55
Absolutely.
16:55
And I really look forward to the discussions that we're going to have, Kate.
16:59
Well, thank you, Mark.
17:00
Thank you to our listeners.
17:01
And as we both said, do participate in the round tables that are underway.
17:06
Look on our website for the helpful material that will give so many of our listeners, we believe, some really helpful guidance and tools.
17:14
Bye for now.