Audit of Small Companies

The duties and responsibilities of the auditors in respect of the individual small company client are the same as in larger audits and the satisfactory accomplishment of the work requires the skilful adaptation and application of the principles of auditing to the individual case. Because the relationship with the directors is frequently less formal, it is particularly important that the arrangement and scope of the work should be clearly defined and recorded. A number of problems relating to small companies and procedural matters of importance in this respect are, therefore, given in the following paragraphs :

(1) Letter of Engagement – It is advisable for the auditor to submit to their client and to receive an acknowledgement of the precise scope of their responsibilities both in respect of the audit and any additional work to be undertaken. At the time of engagement, the auditors should explain to the
directors management’s responsibilities for the preparation of the accounts and establishing a system of internal control appropriate to the needs of the business. The letter should also explain the reliance which the auditors can place upon an effective system. This should subsequently be confirmed in
writing, possibly in the engagement letter.
(2) Internal control – At an early stage in the audit, the auditors should take care to bring to the directors’ attention their findings on the system of internal control. Problems in small companies arise in the application of auditing principles and procedures. Due to inadequate staff they are unable to apply these principles in totality. These problems mainly arise from :

  •  substantial domination of the accounting and financial functions by one person; and
  • limitations in the effectiveness from the audit point of view of the system of internal control rendered inevitable by the small number of employees.

Either or both of the above points can be present to a significant extent in most of the small companies. The major difference from the audit point of view between the small company and the large company will be the extent to which the system of internal control and staff organisation provide a check on the
work of one person so that it is proved independently by or is complementary to the work of another. Whilst internal control and internal check in a small company may be effective for its primary purpose as a check for management use, they would be defective as a check on management itself. These
limitations in the effectiveness of the internal control from the audit point of view may so reduce its value that the auditors will need to consider extending their audit procedures. This will require them to increase the amount of testing of transactions and to intensify the procedures for the verification of
liabilities and assets including, for example, verification of stocktaking and confirmation of debtor balances by direct communication. Where shortcomings in internal control arise because of small number of employees, the internal control letter, whilst acknowledging this should include suggestions for improvement. In such circumstances these would frequently take the form of suggestions for strengthening the director’s supervision and control. In the audits of small companies it will become necessary, despite an extension of detailed audit procedures to rely to a more significant extent on the representations of management, frequently not directly confirmed by outside evidence or by opening of or records maintained by other personnel of the
company. In these circumstances, the auditors must consider whether their examination of records of the company, the evidence available to them and their knowledge of all the circumstances affecting the company are consistent with and support the representations of management for which direct
confirmatory evidence is not available may not be relied on by the auditors. They must consider whether the surrounding evidence as a whole is consistent with and sufficient in their judgment to support these representations to their satisfaction. If in the circumstances the auditors form the opinion that the records are adequate and have been properly maintained, they may place reliance on them as a basis for the preparation of accounts showing a true and fair view. However, if they are not able to do this, it will be necessary for them to state clearly in the report the reservation they have to make.

(3) Letter of representations – After discussion with the directors at the conclusion of the audit and before signing the auditor’s report, a letter of representation on the company’s letter head addressed to the auditors should be obtained. The purpose of such letters is to place on record representation of management on significant matters affecting the account such as the ownership and basis of stating the amount of assets, liabilities, and contingent liabilities. In addition, they act as a reminder to management of their responsibilities. Such letters, however, do not relieve the auditors of any of their responsibilities.

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