The Audit of Small Entities

What are the issues around the audit of smaller entities? To me - as a provider of audit software to small provincial audit firms through to large registered firms - the first issue to address is the question of which firms are most appropriate for this work? In my opinion there is a strong case for supporting small local audit firms to audit the numerous and varied small entities that surround them and form the fabric of their local communities.

The small audit environment

Most of the smaller entities requiring audit will be Public Benefit Entities; clubs, charities, service organisations and community groups. Over 95% of the 27,000 NZ registered charities fall into Tier 3 and 4 PBE reporting (expenses under $2 million). Granted, only charities with annual expenditure over $1million will be required to be audited, and those with over $500k will need to be reviewed, but there are many smaller entities who are currently audited or reviewed as a matter of course because of the comfort level it provides to their members, the requirements of their funders or the stipulation of their founding documents.

The new requirements for the audits of charities and the new Tier 3 and 4 PBE reporting requirements have opened up some new possibilities for firms that specialise in this work. Smaller Charities could get away with almost anything in terms of financial reporting and auditing up till now. But from 1 April 2015 they be required to conform to standard reporting packages as required by Charities Services.

In addition while there is still not the specific requirement that this work be performed by a Chartered Accountant, the reporting requirements will likely lead to more organisations seeking out professional help, hopefully leading to new work and an increasing need for qualified specialists in the audit and review of Tier 3 and 4 PBE’s. Considering that there are only about 1000 NZ charities that fall within Tier 1 and 2 PBE requirements, even if only a third of the remaining 26,000-odd require audit or review this is a significant number of jobs. Someone has to do this. Who would want to?

Why should smaller local firms conduct smaller local audits?

Firstly, smaller firms are often able to do smaller audits more cost-effectively than larger city firms as their overheads are lower. While risk may not be lower (certain kinds of risks with volunteer-based entities are obviously higher) the complexity and scope of these entities - along with the reporting requirements - is at a lower level in general.

Secondly, local firms tend to know the “inside story”. They have local knowledge, living among the community where the entity functions. Of course there are independence issues to address, but in general knowing people and rubbing shoulders with others in a community can be a huge advantage to an auditor.

Thirdly, smaller firms that relate to a certain town, suburb or locality are often a intrinsic part of their communities and see the social benefit of their work as essential - going the “extra mile” - beyond what they can earn from the job. The wellbeing of their entire community depends on the ongoing health of a the clubs, charities, and social services that function within it and the local firm is well aware of this and is motivated by it. In times when there is talk of “zombie towns” the accountant may well be taking a critical role in promoting social cohesion in the town or rural area where they have invested their lives and their family’s future.     

Finally, they often see their audit work as leading to other work that is likely to give a higher return. Attending AGM’s and effectively networking with trustees and board members inevitably builds trust that leads to other work. It makes sense for local smaller firms to continue to audit smaller PBE’s.

Two diverging streams

Why not just go with the flow and let big city firms do all the auditing? The trend I see in the Auditing profession in New Zealand is the divergence of two quite distinct groups of auditing firms.

Firstly firms that are choosing to go all the way toward a full auditing practice covering particularly the “top-end” of the market - Tier 1 and 2 type PBE and FPE audits. These kinds of firms require a great deal of commitment in terms of staffing, ongoing training, quality control, peer review, partner rotation, insurance overhead and the need to stay abreast of the complex IFRS requirements for these jobs.

As a result these types of firms tend to need the economies of scale gained by being part of a network or association of firms. Predictably we are seeing an entrenchment of firms who do this top-end type of work - effectively about 20 NZ firms or associations represented by about 144 licensed practitioners. In many of our provincial towns and cities there may be one audit firm in this group but in many cases there will be none. This is unfortunate as there are likely to be entities that require the skills of licensed auditors in most places and instead of the revenue circulating in town it is being sucked out to another city. Perhaps with the level of specialisation required this is inevitable.

Secondly we have firms that previously covered a wide range of audit work but do not have the resources or desire to be licensed auditors, or to specialise to the extent that they need to understand IFRS requirements. In many of our provincial towns and cities there are also a shrinking number of audit firms in this group. When city firms come in to do this work it is both unfortunate and unnecessary. It is a great pity because as well as scarce resources leaving the struggling community there are very likely accountants with an appropriate skill level in that community that should have been doing this work. As we have seen there is a significant amount of work that fits within their skill-set and very good reasons for them to do it.

The problems facing small local audit firms

As I do training for Audit Assistant I talk to practitioners from small and provincial firms all the time and I often hear tales of what a hard time they have with their audit work. They talk about how absurd and complex many of the ISA requirements are for small jobs. They feel a lack of understanding on the part of the Institute of what it’s like in the world of the small practice - how they are often told what they are doing wrong but not how to do it better - and how the Institute seems to only have eyes for city-scale audit work. It’s easy to see why many small firms have dropped out of audit work or are contemplating doing so.

In part I agree with their perspective, but sometimes I think these practitioners are wanting to go back to a world that no longer exists. The world has changed and some adaptation is required. What I don’t like seeing is good auditors dropping out and leaving their local charities unserviced and struggling to find an auditor.  Will the larger firms want to take on these small charity audits when the potential fees are so minimal? If they charge commercial “city” rates would these smaller entities simply avoid the need for audit or review, placing themselves at risk? Or would many just close up shop because the cost of remaining as a viable entity is too great?

Yes small firms have their problems, and some are simply expecting too much to just add a couple of audits into their mix of work, but many can survive and thrive with a focussed auditing function. Most of the problems that Practice Review identifies are real. It can be hard to get specialist auditors in smaller and provincial firms. The problem of lack of adequately trained staff and part-time auditors means “changing hats” from compilation/tax to audit - something that doesn’t come easily to many. There may be a lack of appreciation of risk assessment and materiality issues. As a consequence jobs may either be over-audited because of inadequate planning (tick and bash), or under-audited in important areas because inexperienced staff lack “big-picture” analysis skills (missing the wood for the trees). 

Sometimes there is a lack of appreciation of the scope of the Auditing Standards and the need to document the work done to address these standards - as if the scale of the job precludes the need to cover all the standards. There may be a lack of understanding of the fundamentals of best auditing practice - the “spirit of the law” on which the “letter” of the Standards rests.

To be fair though, reviewers are often very complementary of small firms that are using Audit Assistant well, and practitioners also ofter tell me how their reviewer was helpful and fair.

What can be done to help small and provincial audit firms?

While they are the obvious choice for small local PBE audit work, these firms are struggling. These firms are often under fee pressure from their already under-resourced, overburdened clients. They are trying to comply with the ISA’s, pay insurance policies (which are disproportionate to their audit fees), cope with expensive Practice Review (for which they see little value) while trying to somehow navigate the choppy waters of providing a great service to their community in a way that allows them to sustain their business, employ staff and still have a life.

In order to sustain this work these firms need resourcing. Software like Audit Assistant that focuses on SME audits and has a low entry cost is an attempt to support these kinds of firms.

Our current response is our Regime Selector tool, a new Review Engagement template in terms of the the new ISRE (NZ) 2400 standard which will be released shortly, and some new tools we have in mind to assist with preparing Tier 3 and 4 PBE reports.  

I also hear these firms asking for Institute training courses that focus on supporting and equipping auditors for this kind of work - taught by auditors who have appropriate background and recognise that small audits - especially for PBE’s - are massively different from large commercial audits.


Overall smaller auditing firms who see the support of the local public benefit entities they serve are doing a great job. They recognise the social benefit in what they do and how important their role is in helping smaller organisations that are very often volunteer-based to stay viable. With appreciation, support and ongoing appropriate training they will be able to continue their important service in the care of these numerous smaller public benefit entities, looking beyond a pure profit/risk criteria at the social capital that they are helping accrue in their communities.

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