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 technology. The truth is we have done it before and we can do it again!
As such, we have devised a series of articles in order to give you the confidence and direction you need. Here are the topics of this series of articles profiting from smaller audits without huge technological investments:
- Considering some practical pre-conditions for smaller audits.
- Applying quality control standards to maximize small audits quality and efficiency.
- Maximizing efficiency by abandoning tradition and collecting the minimum evidence, for both quality and efficiency.
- Training and equipping staff personnel for performing quality smaller audits.
- Preparing minimum standard documentation on smaller audits.
- Maximizing engagement leader participation on smaller audits.
- Simplifying engagement review procedures.
- Wrapping up smaller audit engagements in record time.
- Selling the service advantages of the smaller CPA firm.
- Planning smaller audits in the future with practical, cost-beneficial technological applications.
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 high levels of sufficiency and were filled with that “warm-glow” feeling.
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! Still, for most smaller audits the preferences of many CPA firm leaders perpetuated the evidence collection patterns of the past and huge budget overruns continued.
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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 eventually new auditing standards, on smaller audits and still make 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 series of articles as we consider how to minimize investments in technology, produce audit quality, compete with larger firms and make money on smaller audits!
Defining a Smaller Audit
Auditing literature doesn’t define a smaller audit. Obviously not new news, a smaller audit is an audit of a smaller business! So, let’s consider the nature of a smaller entity. The AICPA’s Financial Reporting Framework for Small- and Medium-Sized Entities (FRF for SMEs) provides some guidance.
The accounting principles for the framework indicates the determination of a small business is relative to its nature, or characteristics. Here are some of the characteristics applicable to a smaller business or entity from the FRF for SMEs:
- The entity may be closely held, owner-or director managed
- A majority of the management personnel of the entity have no intention of any filings with the SEC
- Management and/or owners of the entity rely on a set of financial statements to confirm their assessments of performance, cash flows and of what the entity owns and what it owes
- The entity does not operate in an industry in which the entity is involved in transactions that require highly specialized accounting guidance, such as financial institutions and governmental entities
- The entity does not engage in overly complicated transactions
- The entity does not have significant foreign operations
- Key users of the entity’s financial statements have direct access to the entity’s management
Users of the entity’s financial statements may have greater interest in cash flows, liquidity, statement of financial position strength and/or the effectiveness of the entity’s use of resources. The entity’s financial statements support applications for bank financing when the banker does not base a lending decision solely on the financial statements but also on available collateral or other evaluation mechanisms not directly related to the financial statements.
Some Operational Characteristics of a Smaller Entity
A primary characteristic of a smaller entity is the number of accounting personnel it employs to which it can assign internal control activities. A smaller entity will ordinarily be one with one to three or four accounting employees.
Operationally, a small business may have some or all these characteristics:
- Entity level controls, or key operational controls, are generally performed by one or a few individuals
- Segregation of accounting duties is usually limited due to a small number of employees
- Policies and procedures are generally informal and not formally documented
- Accounting software is usually basic and out-of-the-box
- Management personnel may have limited accounting knowledge
- The risk of management override of internal controls may be high
- Accounting personnel and persons charged with governance may have limited accounting training and/or business experience
- Employees may have easy access to the entity’s assets
A Practical Definition of a Smaller Audit
The audit of a smaller entity with the characteristics described above, may possibly require 50 or 60 hours or even several hundred hours. It is an audit of a smaller entity that may possess some of the characteristics described above.
Generally, the smaller entity will employ a limited number of accounting personnel and will be operated and managed by one or few persons. Smaller audit strategies and plans will incorporate the requirements of the Clarified Auditing Standards and practically focus on ways to maximize efficiency with using only certain technological applications.
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 smaller audits, the good news is that this is still the key to success!
The next article in this series will discuss pre-conditions for smaller audits that provide a framework for maximizing both audit quality and efficiency.