The FRC's market study on SMEs

Jenny Faulkner and Gemma Archer discuss the FRC's 2025 campaign to support UK SMEs and how the market study presents a once-in-a-lifetime opportunity for firms to have their say and impact the future of the audit profession from an SME perspective.

For more information on this topic and more, please visit www.mercia-group.com for further details.

Transcript

Jenny Faulkner: Hello and welcome to our podcast on the SME market and where we are going with it. So today I'm joined with my colleague Gemma Archer, one of our file reviewers and senior managers within the business here at Mercia. So. My name's Jenny Faulkner. I'm head of audit accounts and compliance here at Mercia, and me and Gemma are really care, just to chew the flat a little bit around the audit profession at the smaller end. 

Probably an area that's close to both our hearts. I think it's fair to say, wouldn't you, Gemma?  

Gemma Archer: Yeah, definitely. My, I think my specialism when I was in practice was charity and. Not for profit. So they do come in many shapes and sizes. But yeah, a good chunk of my foot portfolio was entities that fell into that SME bracket. 

So working with firms now where SMEs are their bread and butter, I can certainly sympathize with the need to balance your efficiencies and delivering a cost effective audit with that audit quality.  

Jenny Faulkner: Yeah, absolutely. As you say, we are both file reviewers here at Mercia. I suppose that's what we predominantly spend our day-to-day jobs on, and we see the good, the bad, and the ugly. 

I think it's fair to say on those fronts, but we are not here to challenge what smaller scale auditors are doing. We are really here to try and encourage audit firms to. Give us some information. Okay, so what do I want to know and why do I want to know it? Let's start there. At the beginning of this year, the FR State highlighted in its annual update that it was going to be looking at a number of priorities over the coming year. 

One of them being to support economic growth and really I think the wording they used was embedding proportionality and reducing unnecessary business burdens. That sounds fantastic. And actually, if we think about here in the UK, we've already had changes to company size thresholds, so we're certainly seeing a little bit of deregulation, I suppose, from that perspective. 

But the FRC have fast forwarded a few weeks into, I think it was the beginning of this month. We are standing today on the final day of February. I can't believe I'm saying that. Where has February gone? But at the beginning of this month, the FRC came out and said they were going to look at a campaign to support. 

The UK SME market, so the small and medium sized enterprise market, and really they want to support this particular market to, to help grow and to help support, I suppose, is a huge part of UK industry. Okay. The ma, the majority or the number of corporates within the UK actually sit within the SME market is a really significant figure. 

So what the FRC is thinking about is we want to ensure that those corporates and other entities as well, and I'm sure we'll talk about perhaps not-for-profit a little bit later on, but want to ensure that those firms as individual entities are able to secure audit services at a proportionate cost. But they want, still want to make sure that they can grow and that the auditing firms that provide those services are interpreting them correctly, applying them correctly, and are therefore giving the assurance that is needed from the market. 

So the FRC have come out, in fact, they're gonna look at three things this year. First one being they're gonna do a market study. SMEs. Second one being, they're gonna provide some guidance to support that proportionate audit, so guidance for the audit firms themselves. And then thirdly, provide some guidance or some support material for the SMEs. 

So for those corporates or not-for-profits, whatever they may be. So really what I want to talk about today, myself and Gemma, is around. The first and second one of those. So what's this market study and what additional guidance might we see? So the market study really interesting because. We know that the FRC have historically, perhaps always been very involved in those bigger, larger, more complex audits. 

And certainly if you think about them from a. A regulation perspective, then, you know, the A QR is the regulator of the pie market, for example. So very focused on that area. And they've often that the RSPs, the ICAW, the A CCA, sort of be more active in the SME market, but they're taking a different stance. 

They're saying, okay, we, we want to know more. We want to be able to help. But in order to do that, we need to understand what people involved in that market are thinking. And they've come out with six consultation questions and they're asking the market these six questions and asking people to reply and. 

The consultation's open for looking at today's debate just under two months time, really? So towards the back end of April, there's six questions. I'm not gonna read them all out or anything like that. Please do go to the FRD website and have a look though. But the six questions on there. Three. The first three are perhaps more gained at the SME itself, whereas the latter three questions are perhaps more relevant for the audit firms. 

So let's focus on that.  

Gemma Archer: Yeah, I think it's really, it's really interesting actually to see the FRC sort of. Sudden what feels like suddenly sit up and take notice of what's going on in the SME audit market. I'm wondering if some of that is because they've, I suppose, always had an interest in pies, as we've said, but also with the different tiers of, of firms. 

Perhaps they're sort of looking at those certainly tier two and tier three firms and thinking if we're seeing what we perceive as issues on. Pie audits from most firms where perhaps they're. Broader client base is going to be SMEs, then perhaps that's sort of fueling that interest. I know that obviously they're trying also to try and sort of get more firms perhaps involved in pie audits. 

I'm not sure how successful that's necessarily going to be. Certainly, you know, if they're go, if they want more firms to be involved in pie audits and diversify that market a bit more, then quite clearly they're going to need to. Give firms the tools and in some cases the, I suppose, almost the license to actually make judgements about how to apply some of those auditing standards and things like that. 

So. I know we're gonna talk a little bit later on about sort of scalability and things like that, but scalability does seem to be a bit of an issue within those, and I think any resources that the FRC can put out there that are going to encourage firms to. Look for those scalability elements of the ISA framework is very positive in driving forward a more efficient, more cost effective, but also a sort of quality focused market. 

Jenny Faulkner: And I've got those sort of latter three questions. I'm just gonna briefly touch upon them. So the, the questions are what, if any, challenges do audit firms experience in relation to audits for SMEs? What, if anything, would you like to see change in relation to SME audits? And what, if any, fourth common developments might the FRC want to consider as part. 

Part of this market study. So they seem to be very open around where this could lead to, and I think that's a real positive stance that the FRC seem to be taking, I think. I'm probably not the only one out there that I'm a little bit nervous as to whether they will take everything forward, the market, the profession perhaps suggests, and we can get into a bit more of that detail as we talk our way through the next sort of period. 

So what, let's just talk about what we think are the challenges that audit firms experience, because we review lots and lots of audit files, specifically within the SME market. So do you wanna just highlight what you have as those sort of top challenges?  

Gemma Archer: Yeah, so I think as I've just, I suppose if I've just sort of said scalability and understanding where. 

Requirements can be scaled depending on the nature of your firm. Yeah, and I think some of that comes from, perhaps in some cases, a lack of understanding of the IA requirements. So. Certainly from speaking in to people in practice quite a lot of the time, sometimes we, as file reviewers talk about what the ices say when we are trying to make points about how audit files and audit quality can be improved. 

And it does feel like sometimes we are saying things that perhaps. Whoever's listening to us is hearing for the first time, or perhaps hasn't thought about since they did their exams, for example. Because, you know, in a day-to-day busy firm, you haven't got time necessarily to be, you know, looking up the ISA requirements and thinking about what does that mean for scalability. 

And I also think that sort of coupled with that, there might be a. A bit of people feeling like they've been burnt in the past when they have tried to scale perhaps in regulatory reviews and the like. I think audit is as a profession, probably not quite valued in the way that it should both sort of amongst. 

Sort of those actually doing it from time to time. But also, I don't know necessarily that it feels like the SME sector value their auditors in the way that perhaps Pies do and perhaps other sort of. The not-for-profit sector, for example, I think does perhaps value its auditors a little bit more in a way. 

So it can be quite hard, I think, for firms to justify things like their fee levels. You know, they do, you know, you do need to be able to put in the time and make your audit sort of commercially viable. And if the ices feel like they're getting longer and feel like. You need to spend more time on them, then that presents a challenge because how do you justify that? 

I've definitely, you know, had clients in the past say, you know, the fact that your regulation's getting greater, that's not my problem. Why should I worry about that? I'm still getting the same report. So I think that's the, the second challenge that probably needs to be considered or certainly a factor that contributes that context. 

And then I suppose in terms of the sort of. The workforce. We traditionally see audit as a bit of a training ground. You know, most or the vast majority of accountants in practice, you know, are coming through sort of the traditional sort of a CA or A CCA or icas Chartered or certified roots are coming through. 

In audit. And so we do have this naturally sort of transient, almost workforce coming through there, which means that, you know, a good proportion of those people will do audit for three years and never touch it again because they go off and do other things. And that does mean that there isn't necessarily that building of sort of the depth of knowledge necessarily in terms of your field teams in. 

The way that you know all we can. Think about how we actually approach this audit more, more efficiently or more effectively, sort of on the ground in the moment. It can be a little bit more, that's what the audit plan says, so we have to do it. Whereas actually, if you had more experienced or more confident. 

Auditors sometimes on the ground that might be the case. And I think all of that is sort of coupled with this point about the, the profession generally, perhaps not valuing audit. It is seen as difficult, it is seen as long hours. It does require some quite challenging soft skills. It requires professional judgment. 

It requires at times being pragmatic. It requires having good communication skills as well as all of the technical stuff of both accounting and audit that comes with that. So I think there's quite a lot there for the FRC to think about.  

Jenny Faulkner: Absolutely. I. Listeners who have ever met me would know. I've been busy scribbling things down on my bit of paper as you were talking. 

And I just wanted to al almost just dive a little deeper into a couple of things that you mentioned. And obviously scalability is, is got to be the top one on the list for me. Yeah, a hundred percent because. Just as a bit of background for listeners, I sit on the ISA panel for I-C-A-E-W, so I am involved in looking at the ISAs as they're developed at the international level for ICAW, and that's such an interesting and rewarding panel to be involved in, you know. 

If I think back to, you know, 10 years ago when we were looking at the ISIS as they sort of went through approval processes, they were, you know, still relatively short. We had just probably had that sort of clarification. Project did enhance things a little bit, but as I've thought about the last 5, 6, 7 years. 

The standards are just getting longer and longer. We can talk about ISA 3 1 15 until the cows come home, but I think it's a real classic example of what's happened to the whole suite of standards over that period because the length of that standard I feel for the SNE audit profession is always quite prohibiting. 

Because it's quite challenging to understand sometimes, and this is me and you talking Yeah. Technical accountants whose day to day job is to understand these. Yeah. To try and make them more practical, but. They're, they're lengthy. They're detailed. You really have to think hard sometimes about, well, what's this requirement and what does it want me to do, and how's it interlinked with another requirement and something further down. 

And how does that link into the application guidance? If it's in the application guidance? Do I mean to do it or is it just application guidance? What do the regulators think? And I'm re I was really glad that you sort of picked out this, and I think you, you did use the word nervousness. Uh, yeah. Because there is a genuine nervousness within the profession around. 

Stepping in the wrong direction, not doing enough. And so we do sometimes gold plate things because we're nervous at the end of the day. And I see that as the profession as a whole. Yeah. Not as in at an individual level. So scalability for me is absolutely the big concern. And what we have nowadays are standards that have been written for. 

The larger, perhaps more complex audits rather than the SME. And instead of it sort of being bottom up, it, it's now very much top down approach. But that's challenging. And if we think about. And I do just want to touch upon not-for-profits right now because if we think about the UK market and we think about, let's assume we're in the future world and we've got the new companies hacked size criteria, and we are thinking about audit exemption threshold. 

I mean, 50 million, that's a pretty big figure, isn't it? Yeah. Yeah. And if we compare that very broadly to say, picking up a charitable company, okay, yeah. Here in England and Wales. I'll forget Scotland for a moment. No offense, but let's not complicate things we throwing in different charity audit exemption levels. 

You know, the limit. There's a million in in England and Wales that that's a huge difference. And yet you'll be applying exactly the same  

Gemma Archer: auditing standards. Precisely. And you know, and if we do bring in Scotland and indeed I think Northern Ireland as well, we are bringing in 500, will be that limit. And it's just, yeah, it's just. 

It's quite baffling, isn't it? And you know, there's other, obviously there's other elements there aren't there to take on board in terms of what those entities are doing and why they need scrutiny at a lower level. Sure. But if we actually take it in, in, in terms of what's in those ISA, require, clearly a 15 million pound business is going to have very different processes, resources to support those processes than. 

A million pound charity and it. It does feel slightly out of step. I think the other thing I'd pick up on is just what you've said about the sort of top down and bottom up approach, which is that when we are designing certainly the financial reporting side of things in the charity sector, the SOP committee, when they're writing the sort, look at the smallest charities first and think about how it's going to work for them. 

Then layer on additional requirements for larger charities. And I do wonder whether in the development process for the ISRs, there does need to be a thinking about small first, in some cases, perhaps not every case. But I think the ship has sail on that  

Jenny Faulkner: front. I think it probably has. I, we are, I almost feel like we are where we are with the full standards and I think it'll be very difficult to change that. 

And I'm gonna, when we talk about. Documentation, but we're gonna come back and delve into this a little bit more. Yeah, but I, there was one other thing that I did want to pick up on, on what you've mentioned around challenges. So scalability, absolutely critical. You talked about value, commercial, viability, all of those things completely and utterly agree. 

But when you started talking about workforce, I, there's so many firms when I'm out talking to them. You know, recruitment and retention a huge problem at an individual firm level. But if we think for just one second. It on a profession level rather than the firm level. Then, you know, retention, recruitment is a problem, but we're almost thinking we've got to keep people in the audit profession and excuse my messy handwriting when I'm looking at my notebook, but I've put not sexy enough. 

So perhaps, um, you know, there's something we could do to, I dunno, just spruce up how auditors are perceived. Uh, you know. You look at the statistics, there's fewer and fewer graduates wanting to be involved in the auditing profession. It is a genuine challenge, and I know it's something that the Institutes A CCA are very much aware of and you know, everybody's trying their best. 

But it's a problem area for the profession as a whole. I mean, I wouldn't suggest that auditors have ever been sexy if, if you were gonna highlight a sexy career, it's perhaps not the one I would put at the top of my list. No, but. We can't, it is an interesting area. Um, we wouldn't be in it otherwise. I loved, you know, when I was an auditor in practice, I loved the challenge of working on so many different types of entity, getting into the debts of understanding how they work and why they work differently. 

And then actually. You know, feeling like you've done some good, if you spot that something's either wrong error or sub, or a control isn't working and actually to a degree being able to influence as well. And throughout that process, you're building a skillset that actually, you know, you look at the statistics of, you know, listed entities and how many they sit on boards and the like, and it's fantastic, isn't it? 

Because. Accountants, auditors, we build skillset sets, which are absolutely vital in those leadership positions. Just, you know, wanted to pick up on that as well. But I'm conscious of time and we said this would be a quick podcast, but it never is when me and Gemma get talking. So I've got one thing before I go onto my next agenda item though, and it's around SME. 

So the FRC have come out and said they're gonna do this market study, they're gonna find out what people want, and it's about SMEs, small, medium enterprises, and the audit of them. And I'm gonna loop this into what I was going to talk about next anyway, because I did wanna talk about the international standard of auditing for CEEs less complex entities. 

So for people who dunno, this is a standard that is, it's an international standard. It is not endorsed here in the uk. It was published. Ooh, a couple of year, just over a year or so ago, it was published. Yeah. I'm just checking my notes. December 23, and that standard is, let's call it a watered down standard. 

It's not watered down in the concept of making Audi easier. To do, but what it does is it brings all of the auditing standards together and it's almost more bottom up than top down because its focus is. On those entities which are less complex. So I'm gonna come back and talk about the standard itself in a few seconds, but what I did want to do was just highlight that I thought was really interesting when the FRC came out and did and are doing a consultation, a market study on SMEs rather than it being on less complex entities. 

Yes.  

Gemma Archer: Yeah,  
 

Jenny Faulkner: I  
 

Gemma Archer: think that's quite interesting and. I know, I know we're gonna sort of talk about the standard in a little while, but I do wonder whether some of that is driven by, maybe it's felt that the standard for LCE might be, might not be as broad as it needs to be to cover SMEs because they are potentially. 

Slight. You know, if you think about it, it's probably not, it's not a Venn diagram. That's a circle, is it? It's probably going to be a lot of overlap between the two. But if you put CEEs on one side and SMEs on the other, there will be those that sit outside of less complex. You can have some quite complex SMEs depending on what they're actually doing, and I sort of wonder that, but I do find that interesting. 

That's the terminology. The FRC have gone with  

Jenny Faulkner: and it will be interesting to read and I probably will read all of the respondents to the FRC consultation. It would be interesting to see how individual firms, and I know the ICAW or responding due course, how you know, how it's picked up on by the profession as to whether that's the right answer. 

Or whether it should be less complex entities that, yeah, it, it certainly ped my interest as soon as I read the word SE instead of LC. But let's just briefly talk about this standard so we know it's been drafted internationally. It, it is taking all of the, what I would consider, the basic requirements, the underlying core requirements of the ISIS, and pulls it into one document. 

It also pulls it into what I would consider a workflow, because that's actually one of the challenging areas of the full ISIS is you've got a standard on going concern, got a standard on estimates. You've got standards on reporting yet. They can interlink it. Lots and lots of different parts of the audit. 

I mean, the going concern one's a very good one. Just as an example, because there's elements that standard, which are planning. There's elements that you would consider to be filled with. There's elements that you consider to be completed, yet they're all in one standard, so you have to rely on basically a software provider and or your own methodology in order to sort of link that into a. 

The IFLC doesn't go down that route. They've tried to draw the elements in at the right stage. Now clearly, you know, just as we were told when ISA 3 1 5 revise came out, it will always be an iterative process. You know, you can't just go through the process and assume you don't have to ever work backwards. 

At some points, there will be potential for new risks to crop up and you know, you need to flow back into an earlier part of the process. But there's some real advantages of having a standard like that. And the reason it was written was because the, there were a number of jurisdictions in the world at the time. 

It started to be drafted that had basically already written something for their own jurisdiction. Remember the Nordic one? There was a Sri Lankan one. Pretty sure there was a French one as well, although I feel like I'm, you know, going back a number of years there, and that doesn't ever feel right. For each jurisdiction to be looking at auditing because the whole concept of having the international standards, that is that we've got comparability. 

So really supportive of that standard. Personally, I was in involved in the working group for ICAW at the time and I remember going to Paris and you know, doing the conferences there, so very interesting area. The. I was very disappointed when the FRC, and that's my personal opinion, not Mercy's opinion. I would like to absolutely caveat it right there and then, but you know, I was very disappointed when the FRC really said, no, we're not gonna have this here in the uk. 

So. For this year, for us to be in this sort of once in a lifetime opportunity of the profession, having the opportunity to go back to the FRC and say, here's what's wrong with the market. Here's what we'd like, and I'm gonna hold my fingers crossed and hope for the best. My personal preference would be, it'd be fantastic if we could get this standard as a bare minimum, though the profession must have. 

Some guidance at the smaller end or the less complex end. Yeah, because if we go back to, I think it was around 2018 when the FRC withdrew Practice Note 26, and sorry if you're a relatively young auditor, this might not resonate with you, but Practice Note 26, it was there to support audit firms on documentation. 

At the smaller end of the market, and when the FRC withdrew that material, we were left with a gaping within the profession. What does good. When we are dealing with these smaller, simpler, less complex businesses. So at the very least, I'm just happy to hear that the FRC is hoping to get some guidance out in this. 

My preference is that we have an I rlc, but there are lots of pitfalls to that and I know we've spoken about them before this, the whole concept of perhaps. Ending up in a two-tier audit profession. I think we're already in a two-tier audit profession. Personally, I think it would lead to a three-tier audit profession. 

The high audit market and the non-pay audit market. They're vastly different, you know, regulated differently. Expectations pretty different as to what. Best practice may be in those two different areas.  

Gemma Archer: I definitely think that the I, the is LCE needs to be part of that conversation. I'm, yeah, I'm quite happy. 

My personal view is slightly different to yours. I'm perhaps less in favor of it. On its own. And I think it definitely needs to be part of that conversation because there is a vacuum. And equally, I was sort of looking, when I was sort of preparing for this podcast at sort of some of the narrative around why PN 26 was I. 

Withdrawn. And a lot of it was because it had in there example, working papers. That was the primary reason given. And I sort of thought to myself, actually, I think it's right that probably a regulator isn't saying, you know, here's what a good working paper might look like out there. I can totally understand why you perhaps wouldn't want guidance with that in, but actually the. 

That was all in an appendix. The actual content of that practice note really probably should have been replicated elsewhere in, in some cases, 'cause we've created this sort of vacuum where firms don't really know now whether, you know, they can still apply those principles or not.  

Jenny Faulkner: I do think the FRC over the last, I'd say four or five years, have become very good at. 

In their guidance and documentation telling us as accountants or as auditors what good looks like. Yes, and I really hope that they are able to do this within the SME. Or LCE market. Yeah,  

Gemma Archer: it would be I think, really helpful to firms to have that out there. It'd be helpful. Yeah, it'd be helpful to us as well. 

Let's be selfish about this, Jenny. It would be helpful for us. Absolutely.  

Jenny Faulkner: But you know, where are the areas where, what would we, if we had a wishlist, I'd want something on. Risk assessment. I'd want something ongoing concern. I'd want something on estimates. You know, there's some really key areas that we can draw out that we know smaller, smaller audit firms, even audit firms have. 

More challenged with. So lots and lots of areas that I think we can get into some nitty gritty and really be able to showcase what's, what does good look like.  

Gemma Archer: I was just gonna say, I think also probably things like systems and controls is another area and sort of, I know that sort of links in with risk assessment of course, but particularly. 

The IT controls, because obviously with the changes to ISA 3 1 5, that did put more emphasis on the IT environment. And I think it's an area that still firms are struggling with is what is enough? What is too much? If we're a small firm, how do we make sure that we've got the right people with the right skills for our client base? 

Jenny Faulkner: 'cause we all know audit firms. Absolutely want to ensure audit quality. I know they do. I'm speaking with firms day in day out. They absolutely do want audit quality, but they are commercial. Yes. And it's that fine balance, isn't it? Mm-hmm. Yeah,  

Gemma Archer: absolutely.  

Jenny Faulkner: We've told you that the FRC are doing a market study at Meia, we will be doing our own response to the FRC consultation, but we want to be representing all of our firms. 

So what. I would really love and really appreciate is if firms would reach out to me and let me know what their thoughts are, and I want to weave in all of the responses from firms that we will be speaking to. And don't worry, it isn't a Jenny Faulkner response. It is very much a Mercia group response. 

So I will keep my personal opinions to myself. It's very much about trying to bring together the responses as a grouping. I know that a number of firms, because they've already told me, will be doing their own response as well. That's absolutely great, but if you are not, then please do reach out to me and I can, as I say, weave in your thoughts into the overall mercy response. 

It is for me a once in a lifetime opportunity for audit firms. To be able to have a say and hopefully steer what we get, what sort of guidance we get. What sort of standards we have, perhaps I'll say loosely, but it's our opportunity to have a voice and we don't get that very often. So I do hope that firms take the time to be involved in this. 

If you've never emailed me before, hopefully no surprise, my email address is Jenny.Faulkner@mercia-group.com. I am looking to get all responses in as quickly as possible at the very latest, mid-April, but ideally if we could get them coming in through March, that would be brilliant. Obviously, I don't want to sort of be a few days before the deadline and having to incorporate everything at the last moment. 

Thank you very much for joining me today, Gemma. Really appreciate, uh, thank you. You being here and hearing all your views. And thank you to all of the listeners for listening, and please do join us for whenever podcast soon. Thank you. 

Bye bye-Bye. 

Thank you for listening to the Mercia podcast. For more information on this topic, please visit mercia-group.com.