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AUDIT OF SMALL ENTITIES

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Title: 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.
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