On 24 March, the Financial Reporting Council dropped a package of measures that could materially change how audits work for small and medium-sized businesses in the UK. A day later, it followed up with a fundamental overhaul of its audit supervision model. Together, these announcements represent the most significant shift in UK audit regulation for SMEs in years.
If you’re a CFO, FD, or owner-manager of a company that sits below the PIE (Public Interest Entity) threshold, this matters. Here’s what’s actually changing, what it means in practice, and what you should be doing about it.
What the FRC Found
The FRC engaged with over 500 stakeholders — SMEs, capital providers, and auditors — as part of a formal market study into how the audit market serves smaller businesses. The headline finding was broadly positive: the market is “functioning well,” with strong competition and good availability. Nearly nine in ten SME audits are delivered by firms outside the Big Four and the largest UK practices.
But underneath that headline, the findings were more nuanced. Three issues stood out:
1. Audits aren’t always proportionate. Regulatory requirements and supervision practices were leading to more work being done than necessary. Some auditors were, in the FRC’s assessment, over-engineering engagements for smaller, less complex businesses — not because the business required it, but because the auditor feared regulatory consequences for doing less.
2. Standards don’t scale well. There’s a perception — backed by the FRC’s own evidence — that International Standards on Auditing (ISAs) don’t always flex down effectively for smaller entities. The guidance on how to apply them proportionately has been insufficient.
3. Technology adoption is lagging. Smaller audit firms face real barriers to adopting AI and other technologies, often relying on off-the-shelf solutions rather than purpose-built tools. There’s a lack of clarity on how these technologies can legitimately add value in the SME audit context.
The Federation of Small Businesses put it well in their response: small firms have “a tendency to gold-plate their compliance if they are uncertain about how regulators will interpret rules.” That gold-plating costs money — your money.
What the FRC Is Doing About It
The response is a five-part package, and it’s surprisingly concrete for a regulator:
New guidance (Practice Note 28). The FRC has published guidance specifically aimed at helping auditors apply auditing standards proportionately for smaller, less complex businesses. This isn’t a vague statement of intent — it’s a published practice note that auditors can point to when justifying a more streamlined approach.
Direct engagement with SME auditors. The FRC is launching a programme of direct engagement with firms that audit SMEs, to make sure the new guidance is understood and applied. This matters because the gap between what a standard says and how it’s interpreted in practice is where most of the inefficiency lives.
A Technology Sandbox. Through the FRC’s Innovation and Improvement Hub, a new Technology Sandbox will give smaller audit firms access to support when adopting AI and new technology. The practical impact here will depend on execution, but the intent is to lower the barrier to entry for tools that could make audits faster and cheaper.
A working group on supervision consistency. A new working group with the Recognised Supervisory Bodies (RSBs) — that’s ICAEW, ACCA, ICAS, and others — will focus on ensuring more consistency in how SME audits are supervised. If different RSBs are applying different standards of scrutiny, it creates an uneven playing field and perverse incentives.
Engagement on the Less Complex Entities standard. Perhaps most significantly, the FRC is engaging stakeholders on the international Less Complex Entities (LCE) auditing standard. This is the international standard specifically designed for simpler entities, and the FRC is now actively seeking UK input on how it could be adopted or adapted domestically.
The Bigger Picture: A New Supervisory Model
The SME package doesn’t sit in isolation. On 25 March, the FRC announced a wholesale evolution of its audit supervision model. The new approach, which begins implementation in April 2026 for the largest firms, shifts the focus from individual audit file inspections to a more holistic assessment of firms’ Systems of Quality Management (SoQM).
FRC Chief Executive Richard Moriarty was direct about why: “A system designed in a 2018 world is less relevant to a 2026 world.”
The revised model is built around three pillars: risk-based assessment, targeted follow-up work, and thematic reviews supported by corroboratory inspections. For the largest firms, this means less time spent on random file picks and more time spent understanding whether the firm’s quality management system is actually working. For the wider market, the principle of proportionality that underpins the SME measures is the same principle driving the supervisory overhaul.
Anthony Barrett, the FRC’s Executive Director of Supervision, framed it as a shift from checking individual outputs to evaluating the system that produces them. That’s a meaningful philosophical change.
What This Means If You’re Running an SME
Let’s get practical.
Your audit fees might come down. Not overnight, and not automatically. But the combination of clearer guidance, a mandate for proportionality, and regulatory cover for auditors to do less unnecessary work should, over time, reduce the cost of SME audits. If your current auditor is charging for work that goes well beyond what your business complexity warrants, you now have a stronger basis for that conversation.
Your auditor selection just got more interesting. The Technology Sandbox and the consistency working group both point toward a market where smaller, more innovative audit firms can compete more effectively. If you’ve been defaulting to a mid-tier firm because you assumed the regulatory environment favoured larger practices, it might be worth looking again.
The LCE standard is the one to watch. If the UK moves to adopt or adapt the international Less Complex Entities standard, it could represent a step-change in how SME audits are conducted. This isn’t guaranteed — the FRC is at the “engagement” stage, not the “implementation” stage — but it’s now firmly on the roadmap.
Talk to your auditor now. The new Practice Note 28 guidance is published and available. If your auditor hasn’t mentioned it, ask them about it. A good auditor should be proactively telling you how these changes affect your engagement. If they’re not, that tells you something.
A Note of Caution
It would be easy to read these announcements as the FRC going soft on audit quality. That’s not what’s happening. The market study explicitly found that the market is functioning well in terms of competition and availability. The problem isn’t too little audit work — it’s that the work isn’t always calibrated to the business being audited.
Proportionality isn’t the same as leniency. A proportionate audit of a straightforward owner-managed business with clean books and simple transactions should look very different from an audit of a multi-entity group with complex intercompany arrangements, even if both sit below the PIE threshold. The FRC is trying to make that distinction clearer and easier to apply.
The risk, as always with regulatory change, is in the transition. Auditors may be slow to adopt the new guidance, or may interpret “proportionate” as “less thorough” rather than “appropriately targeted.” The working group with RSBs is designed to manage that risk, but it will take time.
The Bottom Line
The FRC has done something unusual: it’s listened to the market, published an honest assessment of what’s working and what isn’t, and responded with specific, actionable measures. Whether those measures deliver real change will depend on execution — by the FRC, by the RSBs, and by the audit firms themselves.
For SME finance leaders, the immediate action is simple: read Practice Note 28, talk to your auditor about how it applies to your engagement, and keep an eye on the LCE standard consultation. The regulatory environment is shifting in your favour. Make sure your audit engagement shifts with it.
If you’d like to discuss how these changes affect your business, or need help evaluating your current audit arrangements, get in touch.