AUDIT OF SMALL ENTITIES

1
AUDIT OF SMALL ENTITIES

• Group Members

2
The Characteristics of Small Entities

• not only size
• but typical qualitative characteristics
• balance sheets totals
• revenue
• number of employees etc
• concentration of ownership and management in a
  small number of individuals (often a single
  individual)
• Few sources of income
• Unsophisticated record-keeping
• Limited internal controls together with the
  potential for management override of controls

3
The Characteristics of Small Entities

• Small business entities ordinarily have few
  owners often there is a single proprietor. The
  owner may employ a manager to run the entity but
  is in most cases directly involved in running the
  entity on a day-to-day basis.

4
ISAs about Small Entities

• ISA 210 Terms of Audit Engagements
• Owner-managers may not appreciate that the
  financial statements are their responsibility
  particularly in case if the preparation of the
  financial statements is outsourced to other
  firms. One of the most important purposes of an
  engagement letter is to communicate clearly the
  respective responsibilities of the owner-manager
  and the auditor.

5
ISAs about Small Entities

• ISA 220 Quality Control for Audit Work
• Many audits of small entities are undertaken by
  small audit firms, which consider the following
  areas
• Professional requirements
• Skills and competence
• Assignment
• Delegation
• Consultation
• Acceptance and retention of clients and
• Monitoring
• With the possible exception of assignment and
  delegation

6
ISAs about Small Entities

• ISA 230 Documentation
• The auditor may have an in-depth understanding of
  the entitys business, however, this does not
  eliminate the need for the auditor to maintain
  adequate working papers
• The audit planning
• An audit program setting out the nature, timing,
  and extent of the audit procedures performed
• The results of those procedures and
• The conclusions drawn from the audit evidence
  obtained together with the reasoning and
  conclusions on all significant matters requiring
  the exercise of judgment.
• In small entities the use of flowcharts or
  narrative descriptions of the system are often
  the most efficient techniques

7
ISAs about Small Entities

• ISA 300 Planning
• A practical approach to the audit of a small
  entity need not involve excessive documentation
  in planning stage. In the case of a small entity
  where, because of the size or nature of the
  entity, the details of the overall plan can be
  adequately documented in the audit program, or
  vice versa, separate documentation of each may
  not be necessary. When standard audit programs
  are used, these are appropriately modified and
  tailored to the particular client circumstances.

8
ISAs about Small Entities

• ISA 310 Knowledge of the Business
• The activities of the small entity, its main
  products and services, and the industry in which
  it operates.
• The management style, aims, and attitudes of the
  owner-manager.
• Any plans for changes to the nature, management
  or ownership of the entity.
• Trends in profitability or liquidity and the
  adequacy of working capital.
• Legal or regulatory issues facing the entity,
  including its relationship with the taxation
  authorities.
• The accounting records
• The control environment

9
ISAs about Small Entities

• ISA 400 Risk Assessments and Internal Control
• Inherent Risk
• increased risk as a result of the concentration
  of ownership and control
• Control Risk
• Many internal controls relevant to large entities
  are not practical in the small entity, and as a
  result it may not be possible to rely on internal
  control to detect fraud or errors (ex. lack of
  segregation of duties). However, this can be
  offset by exercise of strong supervisory controls
  by the owner-manager means of direct personal
  knowledge
• Detection Risk
• Transaction for cash, no regular pattern of costs
  and margins, the available evidence may be
  inadequate to support an unqualified opinion on
  the financial statements.

10
ISAs about Small Entities

• ISA 401 Auditing in a Computer Information
  Systems Environment
• Initiating and authorizing source documents.
• Entering data into the system.
• Operating the computer.
• Changing programs and data files.
• Using or distributing output.
• Modifying the operating systems.

11
ISAs about Small Entities

• ISA 500 Audit Evidence
• the owner-manager occupies a dominant position
  and may be able to ensure that some transactions
  are not recorded and
• the entity may not have internal control
  procedures that provide documentary evidence that
  all transactions are recorded.
• the auditor of a small entity need not assume
  that there will be limited internal controls over
  the completeness of important populations such as
  revenue.

12
ISAs about Small Entities

• ISA 520 Analytical Procedures
• Analytical Procedures in Planning the Audit
• timeliness of processing of transactions by the
  small entity and the lack of reliable financial
  information at that point in time
• not have interim or monthly financial information
  that can be used in analytical procedures
• Alternative conduct a brief review of the
  general ledger or such other accounting records
  as may be readily available or discussion with
  the owner-manager.

13
ISAs about Small Entities

• ISA 520 Analytical Procedures
• Analytical Procedures as Part of the Overall
  Review
• Comparing the financial statements for the
  current year to those of previous years.
• Comparing the financial statements to any
  budgets, forecasts, or management expectations.
• Reviewing trends in any important financial
  statement ratios.
• Considering whether the financial statements
  adequately reflect any changes in the entity of
  which the auditor is aware.
• Inquiring into unexplained or unexpected features
  of the financial statements.

14
ISAs about Small Entities

• ISA 530 Audit Sampling and Other Selective
  Testing Procedures
• 100 of the population or
• 100 of some part of the population, for example,
  all items above a given amount, applying
  analytical procedures to the balance of the
  population, if it is material

15
ISAs about Small Entities

• ISA 545 Auditing Fair Value Measurements and
  Disclosures
• small entity may not have the expertise and
  experience necessary to fulfill the
  responsibilities for fair value measurements
• the auditor should recommend to the owner-manager
  the use of an expert
• If the owner-manager refuses to provide the
  required representation, this constitutes a scope
  limitation and the auditor expresses a qualified
  opinion or a disclaimer of opinion

16
I. PricewaterhouseCoopers, Audit Services to
Small Size Clients, Barriers Faced and Overcome

• Characteristics and Barriers
• a) Internally-
• Companies managed and supervised by its owners.
• Limited personnel with no segregations of duties.
• No formal procedures.
• There are controls without a high grade of
  development.
• Poor technology information systems development.
• Unqualified and untrained employees.
• Few sources of income.

17
I. PricewaterhouseCoopers, Audit Services to
Small Size Clients, Barriers Faced and Overcome

• b) Externally
• Lack of financial resources.
• Lack of tax incentives.
• Informal economy, disloyal competition.
• Lack of reinvestment by the owners.
• Companies focus in market without awareness of
  back office support.
• Complexity in tax compliance requirements.

18
I. PricewaterhouseCoopers, Audit Services to
Small Size Clients, Barriers Faced and Overcome

• PwC helps to maintain independence for its
  clients while it advises them in the early stages
  of their growth. Small Business management
  relies heavily in the external advice.
• We advice the clients not only in audit
  matters but also in the following areas,
• Companies incorporation
• Tax compliance
• Bookkeeping
• Corporate governance
• Payroll

19
II. PwC Clients Segmentation - Audit Approach
PIE
PE
Private Entities - Non PIE - Generally private
proprietary - Local visibility
Public Interest Entities - Subject to
regulations for protecting groups of
people - Generally listed in Stock
Exchanges - High visibility
20
Practices of different countries on SME audit

• Below are represented the practices of first
  world, developed nations, as it is believed that
  those are the models being considered and the
  countries consulted in the corporate law reform
  process.

21
Developments impacting on Small Business
Auditing, Australia

• Harmonization and convergence with
  international standards by accounting and
  auditing standard setters around the world has
  tended to create complex accounting and auditing
  standards. And this complexity has created an
  understanding gap for Small Businesses. This is
  an area to which Australian regulators and
  accounting and auditing standard setters are
  continuing to devote substantial resources.

22
Australia

• All companies require an audit,
• Besides small private companies (revenue less
  than 10 million, assets less than 5 million and
  fewer than 50 employees), sole traders,
  partnerships, and trusts
• Publicly traded trusts and other instruments also
  come within the scope of the Corporations Act and
  trigger the audit requirements.
• Incorporated associations, such as small clubs
  and charities also generally need an audit.
• Other entities may be required to have an audit
  as a result of membership of an umbrella body of
  some sort..

23
New Zealand

• All overseas companies, their subsidiaries and
  publicly accountable companies must be audited.
• All other companies must also be audited but may
  opt out of being audited if all the shareholders
  agree.
• All public sector entities must be audited. There
  are no audit requirements for charities.

24
Germany

• Audit requirements in Germany are usually bound
  to the size of the entity.
• There are three thresholds (total assets EUR
  4,015 million total revenue EUR 8,030 million
  average number of employees 50).
• If two of the thresholds are exceeded on two
  consecutive balance sheet dates, a statutory
  audit of the financial statements has to be done.
  

25
Germany

• Financial statements of entities which are either
  a listed company or a mutual company have to be
  audited no matter what size these entities are.
• Certain statutes require statutory audits of
  financial statements of entities belonging to a
  particular industry (e.g. hospitals).
• Voluntary audits are always possible.

26
Canada

• Private companies are required to have an audit,
  but this may be dispensed with by obtaining
  annually, unanimous written consent of all
  shareholders.
• Distributing corporations which are subject to
  securities regulations due to issuing of
  securities to the public are generally obliged to
  have their financial statements audited annually.

27
United Kingdom

• The United Kingdom Reform Bill proposes that
  public companies, insurance market activities and
  trade union activities are all required to have
  an audit.
• Small companies that satisfy two or more of the
  following criteria (turnover not more than 5.6
  million, total assets not more than 2.8
  million, number of employees not more than 50),
  are exempt from an audit.
• Charities with a gross income of not more than
  90 000 are also exempt.
• Shareholders holding more than 10 of the share
  capital may request an audit.

28
South African Institute of Chartered Accountants
(SAICA)

• Not all companies should require an audit
• The purpose is to eliminate bureaucracy and
  unnecessary administrative requirements for small
  companies
• There is no sense to require small companies to
  be subject to an audit where the cost of the
  audit outweighs any benefits
• The challenge deciding where the cut-off point
  should be

29
SMEs in Transition Economies Strategic Importance

• Provide big job opportunities with small
  investments and in a short period of time
• Utilise local resources more effectively, thus
  diminishing dependence upon imports
• Goods and services produced by SMEs compete with
  imported similar ones and can successfully
  substitute them
• Get adapted to new market demands rapidly due to
  their flexibility
• Offer new products and contemporary forms and
  services
• SME development in the regions essentially
  contributes to regional economic development

30
Objectives for SME Development in Armenia

• Improvement of legal and regulatory framework
• Creation and development of appropriate
  infrastructures
• Financial and investment support
• Support for foreign economic activity (export
  promotion) of SMEs
• Support for innovations and modern technologies
  in SMEs as well as for protection of property
  rights
• Support for application of international
  standards for quality control (ISO 9,000 series)
  in SMEs
• Support for utilization of business information,
  consultation and training services for SMEs

31
Main RA Laws Regulating SME Performance

• Law on State Support of Small and Medium
  Entrepreneurship (December 2000)
• Concept for Small and Medium Entrepreneurship
  Development Policy and Strategy in Armenia
  (August 2000)
• Law on Protection of the Economic Competition in
  Armenia (June 2001)
• Law on Accounting
• SME State Support Annual Programs
• On the institutional level
• Fund Small and Medium Entrepreneurship
  Development National Center of Armenia (SME DNC
  of Armenia, March 2002)

32
Law on State Support of Small and Medium
Entrepreneurship

• Commercial organizations and individual
  entrepreneurs with average number of employees
• Not more than 5 persons are considered as micro
  companies
• Ranging from 15 to 50 persons for different
  industries are considered as small companies
• Ranging from 30 to 100 persons for different
  industries are considered as medium companies

33
Why have an audit?

• External audit becomes a legal requirement with
  the rise of joint ventures in 1989 -1991
• for banks, insurance companies and enterprises
  (both private and public listed and unlisted).
• Independent external audit might be of benefit
  for organisations wishing to attract
  international capital
• larger state enterprises being privatised,
  public interest organisations

34
Issues hindering the audit of SMEs

• Hyperinflation, widespread default on
  interenterprise debt, a large percentage of
  barter transactions and a substantial "hidden"
  economy
• Historical role of tax authorities in the economy
  and enterprise control - how they would reply on
  the audit report when they have their own means
  of control through tax audits.
• Where there is a high level of systemic
  instability with the movement of a country from a
  command to a market economy, the auditor will
  focus upon the legality of the accounting record
  and not upon an enterprise's commercial
  viability.
• On the other hand, outside of the requirement for
  enterprises listed on a stock market to be
  audited, most auditing of local enterprises may
  be focused on tax compliance and accountancy
  advice, rather than auditing.