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How Small CPA Firms Can Survive Smaller Audits

Apr 25th 2019
CPA Firm Support Services, LLC
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You may be one of the tens of thousands of smaller CPA firms performing smaller audits questioning how you can survive the competition for smaller audits with larger firms that can afford huge investments in new technology.

The truth is, we have done it before, and we can do it again. You’ve probably read about auditing in the cloud, continuous auditing, big data analytics or blockchain and may have experienced an unsettling feeling of lack, or even despair!  Like it or not, we are in an age of technological advances in the auditing profession.  Here’s how you as a small CPA firm can survive.

A Look Back into the Future

Some readers may remember the introduction of risk-based auditing in the 1980s. Actually, the theory began long before, but it was in those years a few firms mustered the courage to give it a try.  Risk-based auditing threatened to destroy the club of the “Balance Sheet Auditors.”

To some, it appeared a threat to audit quality. Eventually, a growing number of firms began to profit from these new concepts and, at the same time, produce high quality audits so no longer could we afford to collect audit evidence until we reached the highest levels of sufficiency.  This was the level that some equated with a “warm-glow” feeling that produced rosy-red cheeks.

The truth was we could still seek that addictive warm-glow, but we began to recognize we just couldn’t do it competitively or profitably. Yet for many smaller audits, the preferences and practices of the leaders in some CPA firms perpetuated the evidence collection patterns of the past, and huge budget overruns continued.

For some firms these old patterns and practices continue even until this day. Other firms, however, began to respond with banners held high that said, “We will survive and prosper doing high-quality smaller audits.” More than that, these firms made it their mission to apply the new risk assessment concepts and auditing standards on smaller audits and find ways to make more money. The cliché, “Where there is a will there is a way,” became their motto. 

Many of these firms emerged out of the next two decades equipped to compete with larger firms that were heavily invested in technology. So, here we are again.  As far as audits of smaller entities are concerned, it is time to look at the successful ways of the past and apply them to the future.

This is the purpose of this article as we consider how to minimize investments in technology, produce high audit quality, compete with larger CPA firms and prosper performing smaller audits.

In the Beginning

Achieving high audit quality has always begun with a recognition of the nature and characteristics of a reporting entity.  Tailoring engagement procedures and documentation to the risks and circumstances of the reporting entity has been the key to maximizing profits on smaller audits. For most of the smaller audits, the good news is that this is still the key to success.

In the 1980s, CPAs purchased hardcopy audit guides and practice aids to evidence the planning process and modified the audit programs to fit engagement circumstances.  Most CPAs used standardized, hardcopy working paper files to document evidence.

Then, along came computer software automation…sort of. We could purchase electronic versions of audit guides and practice aids, and we could document some of our evidence on electronic spreadsheets. Some very progressive CPA firms even began to purchase and use basic integrated auditing software documentation packages.

Having created and marketed one of these documentation packages, I observed some firms add significant time charges to audit engagements with the technology, while others did not.  While there were many variables, success was usually experienced when CPA firm leadership carefully evaluated the circumstances of each engagement, i.e., whether it was likely implementation of new software technology would save or increase audit time.

So, here we are today….and tomorrow. Some of the newer audit technology may increase effectiveness and efficiency on audits.  It still depends on the size and nature of the reporting entity.

As CPA firm leaders make these cost-benefit decisions, the tipping point will usually occur at the line between smaller audits and larger ones. In other words, decisions regarding investments in new technology should be directly related to a majority of the needs of a CPA firm’s clients.  Auditing mostly small- to medium-sized reporting entities will normally not justify large investments in new audit technology.

While smaller CPA firms may not need to invest in most of the new audit technology, neither can we do as we have always done. Technological change precipitates change of our old ways.  To remain competitive on smaller audits, CPA firms must design a “new wineskin” for audit practice. What will yours look like?

The “New Wineskin” Smaller Firm Audit Practice

The risk assessment procedures performed on smaller audits usually take a minimal amount of time and often result in reductions in more costly tests of balances procedures.  Discovering that control risk is less than high, even for only a few financial statement classifications, can enable the auditor to achieve high quality while, at the same time, substantially increasing profitability on smaller audits.  The best part: all this is possible without the high cost of new technology.

What the professional standards require is what we do, even for smaller audits.  When we perform the required risk assessment procedures, however, we have the opportunity to take credit for the substantive evidence they produce. 

Believe it or not, an auditor’s purpose is not primarily looking for errors or fraud when performing risk assessment procedures. The primary purpose is to obtain the most cost-efficient substantive evidence possible, so that costlier tests of balances procedures can be reduced or eliminated. This is a key to simplifying smaller audits  (the new wineskin ) and completing them more efficiently, all without the high costs of new technology.

What Technology Works on Smaller Audits?

An auditor’s decision-making about the right investments in electronic audit applications should begin with consideration of the entity’s financial reporting system and the auditing procedures that can be applied considering an entity’s software system.

Following are a few significant auditing procedures and illustrations of electronically assisted applications that are cost/beneficial:

1. Specialized flowcharting software.  Some of us “gray-hair” auditors remember the plastic template with punched-out symbols we used decades ago to prepare internal control flowcharts by hand. Many of us became proficient in drawing rough flowcharts using these templates while interviewing reporting entity personnel. Sometimes this took less time than preparing memo documentation.  Since those times, reasonably priced, specialized flowcharting software has become available.  Standard symbols, drop-down lists, column formatting and draw capabilities have made the use of electronically-prepared flowcharts for documenting an entity’s financial reporting and internal control systems one of the major ways to produce audit quality and efficiency, perhaps even facilitating an era of the rebirth of audit flowcharting.

2.  Reading or scanning general ledger account activity using Excel or other spreadsheet printouts. When an auditor uses a hardcopy or electronic copy of an entity’s general ledger activity for this major risk assessment procedure, it can generate large amounts of substantive evidence for the engagement’s audit strategy.  Using capabilities within an entity’s accounting software. and/or its spreadsheet options, can save considerable time in identifying large and/or unusual transactions for audit investigation.  Some CPA firms are using Data Extraction software on their larger audits for this purpose.

3. Using spreadsheet documentation of risk assessment procedures whenever possible.  Spreadsheet documentation of the unusual matters from reading or scanning general ledger account activity, and from other risk assessment procedures, can eliminate numerous individual account schedules from engagement files.  Columns identifying the location of the unusual matter, the inquiries made of reporting entity personnel, their responses and auditors’ actions or conclusions will provide one multi-page document evidencing the results of risk assessment procedures, as well as providing one location of findings for an engagement leader’s review.

4.  Using standardized, spreadsheet working paper templates to simplify preparation.  Preparing working trial balances, lead sheets, main working papers for material account classifications and other common procedural schedules in a standard spreadsheet format can assist engagement personnel, as well as engagement leaders during the review phase of an engagement. Examples of spreadsheet documentation include analytical procedures, tests of controls, interbank transfers, aged trial balances of receivables, confirmation statistics, inventory pricing tests, deferred income taxes, statement of cash flows preparation and many other applications. 

Conclusion: Pushing the Electronic Envelope

Beyond standardized spreadsheet documentation, many CPA firms are venturing into other procedural and documentation software.  File container software seems to be among the most popular. 

Enabling a CPA firm to store electronic documentation from all functional areas of practice for individual clients facilitates the performance and review of auditing, accounting and tax engagements. This type of software can be linked to software products that provide functions for performing tasks faster than manual methods, even auditing applications and working papers.

So, here is the obvious truth: The cost of what we decide to do electronically must be less that the cost of doing the same thing manually. The cost must justify the benefit!

For a full course on Audit Survival for the Smaller CPA Firm, a two-hour webinar will be presented by Larry Perry on April 26, 2019. You can still register if you use this link.

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