Challenging Audit and Accounting Areas for SMEs

Revenue Recognition

Revenue recognition remains one of the most frequent causes of audit adjustments. This is likely to become more challenging with the changes to FRS 102 from FRED 82, which introduces a model like IFRS 15.

For SMEs, the key challenge will be identifying performance obligations and determining the correct timing of recognition. This can be particularly difficult where contracts involve multiple elements, long-term projects, or variable pricing structures such as bonuses or rebates.

Common pitfalls:

• Recognising revenue too early before goods or services are delivered.
• Failing to adjust for discounts, rebates, or performance-related fees.

Tip: Review customer contracts in advance of year-end to identify when obligations are satisfied and document your rationale for timing of recognition.

Going Concern and Post-Balance Sheet Events

The current economic climate continues to make going concern assessments more important, and more challenging than ever. Auditors are required to evaluate management’s assessment, which should extend at least 12 months from the date the financial statements are approved.

Common pitfalls:

• No forecasts prepared.
• Overly optimistic cash flow forecasts.
• Lack of evidence supporting assumptions (e.g., sales growth or funding availability).

Tip: Prepare detailed cash flow forecasts and stress-test them under different scenarios. Ensure that post-balance sheet events are reviewed up to the date the accounts are signed, as these can have a direct impact on the going concern conclusion.

Accruals and Provisions

Accruals and provisions require careful judgement. It’s often difficult for SMEs to distinguish between obligations that are certain (accruals) and those that are uncertain (provisions).

Common pitfalls:

• Missing year-end accruals for expenses incurred but not yet invoiced.
• Over- or under-provisioning for uncertain liabilities such as legal claims or warranties.

Tip: Maintain detailed year-end schedules and review historical data to assess the accuracy of previous estimates. This supports both the accounting entries and the audit evidence trail.

Director’s Remuneration and Related Party Transactions

Transactions involving directors or related parties are often an area of scrutiny. These must be clearly disclosed under FRS 102 Section 33.

Common pitfalls:

• Incomplete disclosure of director loan accounts or transactions.
• Misclassification of director remuneration or dividends.

Tip: Keep clear records of approvals, repayments, and remuneration decisions throughout the year. Early review can avoid surprises at audit time.

Inventory and Work in Progress

Inventory valuation and cut-off can present significant audit challenges. Work in progress (WIP) introduces similar complexities, particularly in determining what costs should be included and whether the valuation exceeds net realisable value.

Common pitfalls:

• Including obsolete or slow-moving stock at full cost.
• Inconsistent or unsupported WIP valuations.

Tip: Reconcile physical counts to the ledger, document valuation methods, and assess inventory against sales trends to identify potential write-downs.

Management Override and Fraud Risk

Smaller businesses often operate with limited segregation of duties, which can increase the risk of management override or undetected error.

Common pitfalls:

• Lack of review over key reconciliations or journal entries.
• Excessive reliance on one or two individuals for financial processes.

Tip: Introduce simple but effective controls such as independent review of bank reconciliations or supplier changes. Regular monitoring can significantly reduce the risk of error or fraud.