Practitioner’s Guide to Audit of Small Entities: ICAI

Purpose of this Guide

The purpose of this Guide is to provide a practical approach to implementation of the Standards on Auditing that may be followed while carrying out an audit of small entities. Since the Guide is in the form of a checklist, it is also hoped that by using that checklist, the practitioner would be able to maintain appropriate documentation of the audit work.

The Guidance given in this Practitioner Guide will be applicable to small entities only. To be qualified as a small entity, the entity has to qualify the criteria prescribed in this applicability checklist.

Guidance:

The meaning of “small entity” in this context gives considerations not only to the size of an entity but also to its typical qualitative characteristics. Quantitative indicators of the size of an entity may include balance sheet totals, revenue and the number of employees, but such indicators are not definitive.

Criteria for corporate entities to qualify as Small Entity

Section 2(85) of the Companies Act 2013 defines a small company and accordingly for a corporate entity the company has to qualify as a small company as per this section. Section 2(85) of the Companies Act, 2013 is reproduced below:

“small company means a company, other than a public company,— (i) paid-up share capital of which does not exceed fifty lakh rupees or such higher amount as may be prescribed which shall not be more than five crore rupees; or (ii) turnover of which as per its last profit and loss account does not exceed two crore rupees or such higher amount as may be prescribed which shall not be more than twenty crore rupees:

Provided that nothing in this clause shall apply to—

(A) a holding company or a subsidiary company;

(B) a company registered under section 8; or

(C) a company or body corporate governed by any special Act;”

Criteria for non-corporate entities to qualify as Small Entity

For non-corporate entities, qualitative characteristics of smaller entities are given in paragraph A64 of SA 200. The Paragraph is reproduced below.

“Considerations Specific to Smaller Entities

A64. For purposes of specifying additional considerations to audits of smaller entities, a “smaller entity” refers to an entity which typically possesses qualitative characteristics such as

(a) The concentration of ownership and management in a small number of individuals (often a single individual – either a natural person or another enterprise that owns the entity provided the owner exhibits the relevant qualitative characteristics); and

(b) One or more of the following:

(i) Straightforward or uncomplicated transactions;

(ii) Simple record-keeping;

(iii) Few lines of business and few products within business lines;

(iv) Few internal controls;

(v) Few levels of management with responsibility for a broad range of controls; or

(vi) Few personnel, many having a wide range of duties.

These qualitative characteristics are not exhaustive, they are not exclusive to smaller entities, and smaller entities do not necessarily display all of these characteristics.”

The paragraphs given below provide practical guidance in respect of some of the qualitative characteristics of smaller entities given in aforesaid paragraph A64 of SA 200.

(a) Is the concentration of ownership and management limited to a small number of individuals?

Guidance:

Small entities usually have few owners, often there is a sole proprietor. Many owner-managers adopt a ‘hands-on’ approach to internal control issues by personally exercising supervisory controls. The owner may employ a manager to run the business but in most cases, he himself is directly involved in running the business on a day-to-day basis. As the proprietor, the owner-manager has a personal interest in safeguarding the assets of the business, measuring its performance and controlling its activities, but is unable to divert limited management time to such matters as formal internal control procedures. However, the lack of formality does not by itself indicate circumstances giving rise to a high risk of fraud or error. The auditors of a small entity make their assessment of risk in the light of its particular circumstances. The term “owner-manager” means the proprietors of entities who are involved in the running of the entity on a day to day basis. Where proprietors are not involved on a day to day basis, the term “owner-manager” is used to refer to both the proprietors and to any managers hired to run the entity.

(b) Is the entity engaged in uncomplicated activities and has few sources of income?

Guidance:

Small entities typically have a limited range of activities and often specialize in a single product or service and usually operate from a single location. Uncomplicated activities can make it easier for the auditors to acquire, record and maintain knowledge of the business. In addition, in many small entities, accounting populations are often small and easily analyzed, the application of a wide range of audit procedures can often be straightforward in such circumstances. For example, effective predictive models for use in analytical procedures can sometimes be constructed.

(c) Is there a simple and personalized record-keeping in the entity?

Guidance:

Most small entities employ a few personnel who are solely engaged in record keeping. Consequently, record keeping may be simple, customized or personalized, which results in a greater risk that the financial statements may be inaccurate or incomplete.

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